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ICLE White Paper Executive Summary Capital One’s proposed acquisition of Discover Financial Services has the potential to transform competition and consumer welfare in the retail banking market. Through . . .
Capital One’s proposed acquisition of Discover Financial Services has the potential to transform competition and consumer welfare in the retail banking market. Through synergies and cost savings, the new entity would compete more vigorously with other banks and payment networks. Not only will this better serve the public in general, by bringing together the firms’ traditional expertise in the development of innovative banking and credit card markets aimed at middle-income consumers, it would also likely expand financial inclusion among underserved communities. And while some critics have expressed concerns that the merger could harm competition, those concerns are speculative and ungrounded in well-established principles of antitrust analysis. Major points to consider include that:
On Feb. 18, 2024, Capital One Financial Corp. announced that it had entered into an agreement to acquire Discover Financial Services in an all-stock transaction valued at $35.3 billion.[1] Before the transaction can be finalized, however, it must be approved by both the U.S. Office of Comptroller of the Currency (OCC) and the Federal Reserve. The two agencies held a July 19, 2024, public meeting on the proposed merger, and have extended public comments on the deal until July 24, 2024.[2]
The proposed acquisition has engendered substantial public and political scrutiny from critics who claim it would have anticompetitive effects. For example, a number of Democratic members of Congress,[3] as well as members of the House Financial Services Committee, specifically,[4] and one Republican senator,[5] have written to the regulators responsible for reviewing the merger to urge that it be blocked on that basis.
These criticisms of the proposed merger, however, are confused. To be sure, the combined bank would be larger than either of the two companies standing alone. Yet its size still would pale in comparison to firms such as JPMorgan Chase, Citibank, and other retail bank companies.
More importantly, reflexive “big is bad” arguments overlook the pro-competitive benefits of the merger to consumers and the banking industry. By combining Capital One’s innovative style and marketing dynamism with Discover’s existing network infrastructure and widespread acceptance, the new company could provide a viable new competitor to both existing large banks and to the payment-card-network space currently dominated by Visa and MasterCard. The result should be enhanced competition across the board, but particularly in the market for payment card networks, about which many of these same critics of this merger have complained lacks adequate competition due to the supposed Visa and MasterCard “duopoly.” Rather than trying to artificially impose a counterproductive scheme of competition on that market through heavy-handed government regulation, such as the Credit Card Competition Act,[6] the merger would do exactly what sponsors of that act claim to desire: foster more robust competition in the payment-card-network space.
This white paper uses the tools of law & economics to evaluate the likely effects of the merger, with a particular focus on two of the key criteria the agencies are required to evaluate: (1) the convenience and needs of the communities to be served by the combined organization and (2) competition in the relevant markets.[7]
The primary communities served by both Capital One and Discover comprise lower-risk low-income and middle-income consumers who have been underserved by other large financial firms. The merged company will presumably continue to seek to attract and maintain such consumers, while also potentially expanding into other market segments. Indeed, the new company may better serve such communities. This could be achieved through synergies that would enable it to invest in innovation and thereby offer better products at a lower cost. In addition, the combined firm plans to issue debit cards on its own proprietary network, enabling it to offer enhanced products to consumers (because it will not be subject to the price controls and routing requirements imposed on debit card issuers subject to the Durbin amendment and related regulations). For example, the company should be better able to market no-fee, no-minimum-balance bank accounts to underserved low- and middle-income consumers. Furthermore, by combining some credit card operations, the new entity should benefit from scale economies and the ability to cross-market products.
On the competition side, the relevant markets are, broadly, banking (deposits and loans) and payments (card issuance and acceptance, and network facilitation). With respect to the former, the combined company would be the sixth-largest bank in the United States by assets, and roughly one-quarter the size of JPMorgan Chase (the nation’s largest bank).[8]If the relevant market is large banks with national reach, the merger will plausibly result in an increase in competition, as the new entity will have greater scope and scale, enabling it to compete more effectively with other large national banks.
Regarding credit card issuance: recent figures suggest that Capital One and Discover combined would be the largest holder of credit card debt in the nation, accounting for nearly 22% of outstanding credit card loans by dollar amount.[9]Even so, and contrary to claims made by some critics of the proposed merger,[10] there is no reason to believe this would harm competition. The increase in market share for credit card debt would not trigger thresholds inviting close scrutiny under federal bank-merger guidelines, or the 2023 Federal Trade Commission (FTC) and U.S. Justice Department (DOJ) merger guidelines.[11] Moreover, as the company notes in its filing with the regulators:
Vertically integrating with Discover’s payments networks will add scale to these credit and debit networks—which respective market shares are in long-term decline— making the networks less costly to operate on a marginal basis and more attractive to consumers and merchants. The combination will also allow Capital One to lower its transaction-related costs and to reinvest those dollars in improved banking products and services, including investments into the payments networks to reduce fraud, improve dispute resolution processes, and lessen information sharing friction to the benefit of consumers and merchants. These network investments will allow Capital One to further scale the networks, improve the actual and perceived acceptance of the networks, and create a credible alternative to the Visa, Mastercard, and Amex payments networks, which dominate the industry today.[12]
Critics of the merger, by contrast, have failed to articulate any tangible harms to competition or consumers from the merger beyond reflexive “big is bad” rhetoric.
From a law & economics perspective, the merger’s potential to create a stronger fourth network aligns with the theory that increased competition can lead to greater market efficiency and consumer welfare. A more competitive network landscape could pressure all players to improve their offerings, potentially resulting in lower fees, better security features, and more innovative payment solutions. This outcome would be consistent with the goals of antitrust law, which seeks to promote competition, rather than protect individual competitors.
In sum, the evidence strongly suggests that this merger would meet the needs and convenience of the communities served by the combined organization and would be pro-competitive in all relevant markets.
The prospective acquisition of Discover by Capital One would bring together Capital One’s savvy marketing and innovation advantages with Discover’s legacy advantage as a payment-card processing network, thereby creating a new viable competitor to both existing banking giants (such as JPMorgan Chase and Citibank) as well as existing payment networks (Visa, MasterCard, and Amex). At the same time, however, the combined entity will remain a fraction of the size of these incumbent banks and networks. The end result should benefit competition and consumers substantially, especially in the network issuing space.
Discover Financial Services originated in 1985 as a subsidiary of Sears, Roebuck, and Co., arising as a general-purpose spinoff of the legendary Sears credit card program. In 1985, Sears was the largest consumer-lending operation in America, with 60 million cardholders and customer receivables of more than $12 billion.[13] The ubiquity of the Sears credit card owed in large part to the department store’s towering presence in the nation’s retail landscape, and particularly the company’s long-established Sears catalog. Sears had 796 retail stores and more than 3,000 branch offices of its subsidiaries: Dean Witter Financial Services, Allstate Insurance, Coldwell Banker real estate, and Sears Saving Bank.[14] The launch of the general-purpose Discover credit card was part of a larger push at the time by Sears into the consumer retail financial services space, including bank accounts, ATMs, and low-cost retirement brokerage accounts offered by Sears’ Dean Witter Reynolds Inc. brokerage subsidiary.[15] The card was issued through Greenwood Trust Co. bank, which was owned by Sears. Sears was able to capitalize on its relationship with those millions of established Sears credit card customers to launch a new general-purpose card to rival Visa and Mastercard.
The Discover Card’s launch illustrates the logic of two-sided payment card markets and the need to attract both consumers and merchants to the platform.[16] Because of Sears’s existing relationships with 60 million cardholders, Discover likewise found it relatively easy to attract cardholders. The company, however, faced greater difficulty in persuading merchants to take up the card, in part because merchants were reluctant to accept a card affiliated with a major retailing rival (a difficulty further compounded by the fact that the original card face featured an image of the Sears Tower). To induce merchant acceptance, Discover offered a lower merchant discount rate than Visa and MasterCard-branded cards.[17] Today, Discover’s average merchant discount rate remains below that of Visa, MasterCard, and American Express.[18]
To encourage consumers to use the card, Discover’s initial strategy was to differentiate itself by offering a card with no annual fee and a cashback-rewards program for purchases (including quarterly “bonus categories”), both of which were novel and innovative concepts at the time. This helped to attract consumers and carve out a niche in the competitive credit card market.[19] Because of Sears’ massive network of retail stores and affiliates, Discover didn’t need to establish a separate system of bank branches to service customers, a distinctive characteristic that remains the case today (although, today, it is all online). The card was introduced with a 1986 Super Bowl commercial.[20]
One of Discover’s key innovations was its approach to the payment network. Like American Express and Diners Club (at the time), but unlike most other issuers, Discover chose to operate a vertically integrated, “three-party” model, acting as card issuer, acquirer, and payment network.[21] This structure enabled Discover to offer merchants lower fees relative to other acquirers, which helped in building acceptance so that it could compete more effectively with “four-party” cards issued on the Visa and Mastercard networks.[22]
In 1993, Sears spun off Dean Witter into a new company and Discover became part of Dean Witter. In 1997, Dean Witter merged with Morgan Stanley and later rebranded itself as Discover Financial Services Inc. In 2007, Discover Financial Services became an independent company. In 2004, Diners Club (then owned by Citigroup) signed an agreement with Mastercard to provide acceptance in the United States and Canada, making it a four-party card issuer in these markets—and leaving Discover and American Express as the only three-party issuers in the United States.[23] In 2008, Discover purchased Diners Club International from Citigroup, giving it an international payment network, albeit one that today has only a tiny share of transactions. (The U.S. and Canadian franchises of Diners Club were not included in the deal, and were sold by Citigroup the following year to BMO International.)[24]
Consistent with its original plan to evolve into a full-service retail banking establishment, in the late 1990s and early 2000s, Discover expanded its product line beyond credit cards. It ventured into personal loans, student loans, and savings accounts, leveraging its brand recognition and customer relationships to compete in broader financial services. In 2005, Discover acquired the Pulse electronic funds transfer (EFT) network, which provides single-message (PIN) ATM and debit payments for around 4,500 smaller banks.[25]
Despite its early distinction as a market innovator, over time, Discover has grown somewhat stagnant. In terms of credit card market share by purchase volume, Discover has been stuck at approximately 4% to 5% of the U.S. market for almost 20 years and has a negligible global presence.[26] While Discover has a slightly larger number of credit cards in circulation than American Express, Amex’s market share by purchase volume is roughly five times that of Discover.[27] As a network competitor, therefore, Discover has neither the large cardholder base of Visa and MasterCard nor Amex’s highly coveted high-spend customer base. As one news report summarized Capital One’s arguments in support of the deal, “Discover’s network has ceded market share over the past decade and Capital One, as a much bigger bank, can provide the additional scale and volume Discover needs to be competitive.”[28]
Capital One Financial Corp. emerged in the early 1990s as a spin-off from Signet Bank, under the leadership of Richard Fairbank and Nigel Morris.[29] Their vision was to revolutionize the credit card industry by applying data analytics and information technology to consumer finance.[30] This approach, often referred to as “information-based strategy,” allowed Capital One to tailor its offerings to specific customer segments, a novel concept at the time.[31]
The company’s key innovation was its use of data-mining techniques to identify and target potential customers with personalized credit card offers.[32] This strategy allowed Capital One to extend credit to a broader range of consumers, including those who might have been overlooked or rejected by traditional banks.[33] By using sophisticated risk-assessment models, they could offer competitive rates to customers across various credit profiles, effectively disrupting the one-size-fits-all approach prevalent in the industry.[34] Writing in the Financial Times, former Federal Deposit Insurance Corp. (FDIC) Chair Sheila Bair noted:
I suspect Capital One’s subprime market share is relatively substantial because other banks simply have less (or no) interest in serving subprime customers. Subprime lending involves higher capital requirements, greater regulatory scrutiny and more resources to underwrite and manage those accounts. Any concentrations in the subprime market are the result of banks’ conscious investment decisions, not barriers to entry.[35]
Capital One’s market entry coincided with the rise of direct marketing in the financial sector.[36] The company leveraged this trend by aggressively promoting its products through direct-mail offers, a strategy that helped it rapidly acquire customers and market share.[37] This direct-to-consumer approach bypassed traditional banking channels and allowed Capital One to build a national presence without the need for an extensive branch network.[38]
As the company grew, it continued to innovate in product design and customer acquisition. Capital One introduced features like balance transfers with low introductory rates, cashback rewards, and no annual fee cards, which were not common at the time.[39] The company was also one of the first banks to offer a secured credit card.[40] These offerings appealed to consumers and forced competitors to adapt, ultimately benefiting the broader market through increased competition and more favorable terms for cardholders.
Capital One’s disruptive influence extends beyond credit cards. The company has expanded into retail banking, auto financing, and savings products, often bringing its data-driven approach to these sectors.[41] For instance, its online savings accounts offer higher interest rates than many traditional banks, challenging the status quo and prompting other institutions to improve their offerings to remain competitive.[42]
Capitol One’s acquisition of Discover will have manifest benefits to consumers, competition, and innovation in the payment-card market. By combining the advantages of Discover’s existing (but somewhat stagnant) presence in the payment-card-network space and its reach into middle-class consumers with Capital One’s innovative culture in payments and data security and its marketing savvy, the deal offers the potential to create a viable competitor to existing mega-banks and the dominant card-processing networks. As noted, the proposed deal has elicited some criticism from politicians, but none of those criticisms have amounted to much more than a reflexive “big is bad” mentality and vague, unspecified concerns about the potential for harm to competition and consumers. By contrast, the potential benefits of the deal are manifest and concrete.
These benefits are explained in greater detail below, but in broad terms comprise the following two components:
This section analyses the various components of the proposed acquisition. From an industrial-organization perspective, this has both “horizontal” and “vertical” components. Both companies accept deposits, issue loans, offer credit and debit cards, and offer other financial services; the combination of these business lines would therefore be considered a horizontal merger. While such mergers have the potential to be anticompetitive, they can also be pro-competitive, as demonstrated by many horizontal “four-to-three” mergers in the wireless industry discussed in the first sub-section below.
While these horizontal aspects are tasty hors d’oeuvres, the main course in Capital One’s acquisition of Discover is its purchase of Discover’s payment networks, which would facilitate vertical integration with many of Capital One’s existing products (including all of its debit cards).[44] The beneficial effects of this vertical aspect of the merger are addressed in the separate subsections on credit cards, debit cards, and banking. This is followed by a more detailed discussion of the effects of the merger on the identification and deterrence of fraud—and the benefits this would bring to consumers and merchants. The final subsection addresses some concerns raised by critics of the merger.
Some lessons may be learned from mergers in other industries where two mid-size firms merge to create a competitor that is similar in size to the market leaders. An example is so-called “four-to-three” mergers in wireless telecommunications. A survey of empirical research on these mergers, undertaken by a team that included two of the authors of this white paper, provides insights that may help to evaluate the merger between Capital One and Discover.[45]
First, the paper notes the importance of considering both price and nonprice effects when assessing mergers. In the case of Capital One and Discover, while price effects (such as interest rates or fees) are crucial, nonprice factors like investments in technology, product innovation, and service-quality improvements should be given substantial weight.[46] The merger will enable the combined entity to increase investments in digital-banking capabilities, artificial intelligence, and data analytics—all areas where both companies have shown strengths. This increased investment capacity could lead to more innovative financial products and improved customer experiences, ultimately benefiting consumers.
Second, the review of empirical research highlights that mergers can lead to more symmetrical market structures (that is, with firms of more equal size), which may result in stronger incentives for individual firms to invest and compete.[47] In the context of the credit card and banking industries, a merged Capital One-Discover entity could become a more formidable competitor to larger players like JPMorgan Chase, Bank of America, and Citigroup. This increased symmetry in market power could drive all players to innovate and compete more aggressively, potentially leading to better offerings for consumers across the industry.
Lastly, the empirical research suggests that the optimal number of competitors in a market depends on various factors, including geographic and demographic considerations.[48] In the U.S. financial-services market, which is both large and geographically diverse, the merger could potentially create a stronger nationwide competitor. By combining Capital One’s extensive customer base and marketing prowess with Discover’s payment network and reputation for customer service, the merged entity could more effectively compete across different regions and customer segments. This could be particularly beneficial in making Discover a more effective competitor, as it would gain access to Capital One’s larger customer base and potentially expand the reach and utilization of its payment network.
Three networks currently account for approximately 96% of credit card purchase volume in the United States: Visa (52%), Mastercard (25%), and American Express (20%).[49] Discover has most of the remaining 4%, a proportion that has declined from 6% in 2011.[50] Capital One’s acquisition of Discover could potentially create a more robust fourth network, aligning with some legislators’ stated desire for an increase in the number of competitors in this market.[51]Unlike current proposed legislative interventions, however, it also would more plausibly lead to a genuine increase in competition, as Capital One would have strong incentives to identify ways to reinvigorate the network. Unlike some legislative proposals ostensibly intended to promote competition, but which likely would lead to increased fraud, the merger would likely improve the detection and prevention of fraud.
Capital One’s extensive cardholder base and innovative approach to payments could provide the scale and technological edge that Discover’s network has been lacking. Capital One’s data analytics capabilities and marketing prowess could be leveraged to expand the network’s reach, potentially making it more attractive to both merchants and consumers. This, in turn, could lead to a more competitive market in which four major players compete, potentially driving down transaction fees and spurring further innovation in payment technologies.
Moreover, whereas mandatory routing regulations—such as those contained in the Durbin amendment and the proposed Credit Card Competition Act—lead to data fragmentation that would undermine fraud detection, the combination of Capital One’s innovative data analytics with Discover’s networks would likely improve fraud detection. For example, Capital One recently partnered with Stripe and Ayden to build an open-source application programming interface (API) that enables any entity in the payment stack to share real-time transaction data, enabling Capital One to better detect fraud.[52]
The transaction also potentially offers an opportunity for Capital One to shift the debit cards of its current and future bank customers over to Discover’s payment networks. Capital One founder and CEO Richard Fairbank has stated that the company intends to transfer all its debit cards to the newly acquired networks.[53]
By moving customers onto Discover’s three-party payment card network, Capital One’s customers will be able to avoid the distortions imposed by the Durbin Amendment’s price controls. In turn, this will enable Capital One to offer rewards and maintain free checking accounts for lower-income consumers. These price controls only apply to debit cards issued on four-party payment networks, so Capital One will be able to avoid them by issuing debit cards on its own newly acquired three-party network.
Under a provision of the Dodd-Frank Wall Street Reform Act of 2010 known commonly as the “Durbin amendment,” the U.S. Federal Reserve imposed caps on debit card interchange fees for banks with more than $10 billion in assets (“covered banks”), as well as routing requirements for all debit card issuers.[54] As a result, debit card interchange fees fell by about 50% for large banks almost immediately. Interchange fees on debit cards issued by smaller banks and credit unions initially fell by a smaller amount, and interchange fees on single-message (PIN) debit cards have now fallen to similar levels as PIN debit cards issued by larger banks.[55]
Estimates suggest that the Durbin amendment initially reduced annual interchange fee revenue for covered banks by between $4.1 and $8 billion.54F[56] In response, covered banks eliminated or reduced card-rewards programs on debit cards.62F[57] They also typically raised monthly account maintenance fees and increased the minimum balance needed for a fee-free account.[58] These changes have resulted in an increase in unbanked and underbanked households in the United States, particularly among lower-income consumers.[59]
As a covered bank, Capital One might have been expected to have been among those that reduced the availability of free checking. But Capital One’s business model is focused on attracting the very clients who would be put off by having to pay a fee for their checking account. So, as noted above, it has kept fee-free checking accounts with zero minimum balances.[60] It has been able to do this, in part, because of its lower costs as a primarily online bank. As with most covered banks, however, Capital One discontinued its debit card rewards program following the implementation of the Durbin amendment.[61]
Capital One’s debit cards currently operate on four-party networks. By contrast, the Discover card network operates as a three-party closed-loop system, in which the issuer and the acquirer are the same and there is, therefore, no interchange fee. As such, debit cards issued directly by Discover are not subject to the Durbin amendment, which is why it is able to continue to offer cashback rewards of 1% on purchases made on those cards.[62] Shifting all of Capital One’s debit cards over to the Discover network (including, in particular, the PULSE single-message PIN-debit network) would allow Capital One to more effectively balance the two sides of the market, using fees charged to merchants to cross-subsidize holders of Capital One current accounts. This might include:
Another potentially significant benefit of the merger is its effect on fraud, which is a challenge for every party in the payments ecosystem: issuers, acquirers, merchants, and cardholders. Global losses from payment-card fraud were estimated to be $34 billion in 2022, of which 36% was attributed to the United States.[63] Discover, in particular, has had various data security breaches and other compliance issues.[64] By combining Capital One’s innovative approach to data management with Discover’s payment networks, the combined entity could help to significantly reduce such fraud.
Issuers and networks have developed increasingly sophisticated systems to reduce fraud. For example, when a card with a chip is dipped or tapped, it transfers a unique one-time token, generated by the chip, that is encrypted and can only be read by the issuer.[65] The implementation of chip-based tokenized transactions has dramatically reduced fraud compared to the simpler magnetic stripe cards. Mobile payments also use tokens in a similar way.
But tokens by themselves can’t solve the problem of stolen cards and hacked online accounts. Issuers and networks have thus implemented other measures, most notably systems of multifactor authentication. An example is 3D-Secure (3DS), which involves using the information sent in the first (authorization) message to check against a cardholder’s profile. If the proposed payment fits the profile, it is permitted; if not, then the cardholder is asked to complete two-factor authentication on the transaction.[66]
3DS would not be possible without cardholder profiles, which are an example of the application of AI to payments. Since the 1990s, Visa and Mastercard have used machine learning to develop cardholders profiles, which then enable them to identify potential instances of fraud.
Payment networks, issuers, and other companies in the card-processing stack have also begun to use biometrics, typically combined with machine learning, as part of the authentication and authorization process.[67] Capital One has been a leading innovator in such methods, going back at least to its pattern-tracing system for accessing mobile accounts.[68] From 2018 to 2020, Capital One applied for 23 biometric-related patents, including one for voice recognition.[69]
One problem that can reduce the effectiveness of AI-based fraud detection (including 3DS) is data fragmentation. When a consumer has cards from multiple issuers on multiple networks, or where the same card is run by different merchants over different networks (which is currently possible with debit cards, due to the Durbin amendment’s routing requirements), it may be difficult for networks and issuers to build a consistent picture of an individual’s payment patterns. This makes it more difficult to identify attempted payments that do not fit a pattern.
The merger might improve fraud detection in several ways. First, when Capital One’s debit cards are moved to Discover’s networks, they will no longer be subject to the Durbin amendment’s routing requirements, and thus all transactions on those cards will be monitored directly by Capital One’s systems. Second, Capital One will be able to implement its highly innovative fraud-detection and prevention systems across all Discover networks. Third, as noted above, Capital One recently partnered with Stripe and Ayden to build an open-source API that enables any entity in the payment stack to share real-time transaction data,[70] which should help Capital One to address fraud more effectively and in a manner comparable to existing larger networks (Visa, Mastercard, American Express) despite of its smaller size.
These improvements in fraud detection and prevention would have both direct and indirect benefits for merchants and consumers. The direct benefits arise from the simple fact of experiencing fewer fraudulent transactions. For consumers, this means not having to identify fraudulent transactions or go through the process of initiating chargebacks. For merchants, it means fewer chargebacks and related disputes with issuers. The indirect benefit is lower costs all around, which can be passed on in the form of lower fees and/or additional account or card benefits. And these increased benefits should be expected to drive an increase in the use of Capital One cards, thereby generating a virtuous cycle of network effects, whereby fraud can be reduced further, while use and acceptance of the cards are further increased.
Critics of the merger have identified ways the proposed merger could harm banking consumers by increasing the cost of credit, increasing fees, and reducing the interest paid to depositors.[71] There is, however, little evidence the merger poses potential antitrust harm to depositors. Of note:
Capital One and Discover have both been industry leaders in increasing financial access for underserved consumers. For example, most bank accounts in the United States today impose monthly maintenance fees, especially for lower-income consumers who cannot meet the stiffer average balance requirements required to be eligible for free checking. Both Capital One’s 360 Checking Account and Discover’s Cashback Debit accounts offer free checking accounts with no minimum balance requirements. Capital One was also one of the first large banks to eliminate overdraft fees.
With such small market shares, it would be a stretch to conclude that a merger between Capital One and Discover would have any noticeable effect on competition for deposits or depositors in the U.S. banking sector. Moreover, as primarily online banks, Capital One and Discover compete nationally against other online banks, as well as “traditional” banks with substantial online presence. Thus, even if the merged firm were to try to charge above-competitive fees or offer below-competitive interest rates to depositors, such efforts would be likely to fail in the face of competition from hundreds of other competing banks and credit unions.
Based on the above analysis, the prospective acquisition of Discover by Capital One augurs well for consumer welfare. As noted, however, some critics have raised concerns regarding certain aspects of the merger. Here, we briefly review these concerns.
The merged firm would be the largest holder of credit card debt, accounting for nearly 22% of outstanding credit card loans by dollar amount.[75] That, in and of itself, is not necessarily a concern; as Capital One points out in its filing, it would not exceed any threshold in a conventional antitrust analysis.[76]
Much of the concern has been focused on potential harms to specific groups of credit card customers, especially the “near-prime” or “subprime” segments of borrowers with FICO scores below 660.[77] A key question for antitrust analysis is whether these constitute a distinct relevant market. One critic of the merger argues that these consumers’ higher risk, as well as Capital One and Discover’s direct-mail marketing to these consumers, suggest they constitute a distinct “submarket.”[78] In contrast, the Bank Policy Institute reports:
No evidence has been put forth by critics of the proposed merger to define the boundaries of the subprime segment and establish that consumers in this segment are sufficiently isolated for it to be considered a distinct submarket for antitrust purposes.[79]
One important consideration in evaluating this concern is that a consumer’s credit status is rarely static over time. Due to changes in income and other circumstances, a subprime borrower today may be a prime borrower next year, and vice versa. Using data from 2014 and 2015, Fair Isaac found that a “notable percentage” of FICO scores migrated up or down more than 20 points in a six-month period, with 14% of accounts decreasing by more than 20 points, and 19% increasing by more than 20 points.[80] Thus, even if a subprime or near-prime market segment can be defined, migration into and out of these segments makes it exceedingly difficult to establish a reliable market definition for antitrust analysis.
Among consumers with at least one credit card, as of 2023, 8.6% were near-prime and 4.4% subprime.[81] The Bank Policy Institute estimates the merged firm would account for a little less than 30% of subprime credit card balances in the United States.[82] Thus, the authors conclude, “If the subprime consumer segment of the credit card market merits separate scrutiny, our analysis indicates that the segment is highly competitive and would remain so even after the proposed merger.”[83]
It is also worth noting that Capital One gained its market share in “subprime” over time through its data-driven strategy. This has enabled the company to identify lower-risk individuals in (otherwise) higher-risk groups, thereby serving otherwise underserved consumers, while limiting default risk.[84] It also provides opportunities for these consumers to migrate toward a lower-risk category by gradually increasing the size of their credit lines as they demonstrate creditworthiness.[85]
Another important aspect of this strategy was the pioneering of two now-widespread credit card offerings: secured credit cards and balance transfers. In 1991, Capital One became the first credit card issuer to introduce a balance-transfer offer.[86] A balance transfer provides a temporarily low interest rate to induce people to move balances from a competing credit card to the card providing the balance-transfer offer. In short, Capital One’s substantial market share in the subprime credit card market is best explained by its innovative culture in meeting the needs of the heterogeneous consumers in this complex market.
Although perhaps not the first to offer a secured credit card, Capital One was arguably the first issuer to implement a major program of such cards.[87] A secured credit card differs from a traditional card in that all or part of the borrower’s credit limit is secured against a cash deposit provided by the consumer at the time of account opening. Secured cards are most useful to consumers seeking to build a credit history or attempting to repair a damaged credit history.[88] Research published by the Philadelphia Fed concludes that a combination of credit-score migration and increased competition has been associated with increasing “graduation rates” over time from secured cards to unsecured cards.[89]
Finally, for credit card issuers, a merger might result in a more effective competitor to the major incumbents, thereby potentially increasing competition, even while reducing the number of competitors. And a smaller number of larger firms facing more intense competition may be better for consumers than a larger number of smaller, less effective firms.
With respect to payment networks, it’s important to note that the proposed merger between Capital One and Discover does not reduce the number of competitors; it merely shifts ownership of Discover’s network to the merged firm, which would presumably adopt Capital One’s more sophisticated technologies, including those related to fraud detection, as discussed above. In this way, it could be argued that Capital One’s acquisition of Discover’s payments network might result in more effective competition to Visa, Mastercard, and American Express, with broad benefits to merchants and consumers.
A major objective of the merger is, as noted above, to switch Capital One’s debit cards over to Discover’s payment network and thereby circumvent the Durbin amendment’s price controls and routing requirements. This vertical integration could allow for more flexibility in fee structures and potentially higher overall revenue per transaction. This would enable Capital One to offer cashback rewards to debit cards and potentially also cross-subsidize accounts in other ways, such as by offering sign-up bonuses.
Consumers would almost certainly benefit from the increased availability of debit card rewards and sign-up bonuses. Cashback rewards may be especially beneficial to lower-income cardholders. Indeed, it is likely that the reintroduction of such rewards will encourage some lower-income consumers, and especially those with poor credit scores and without access to a rewards credit card, to switch to Capital One. Moreover, the prospect of such rewards would likely entice many consumers who are currently unbanked or “underbanked” (i.e., have access to only minimal banking services) to open accounts with Capital One and thereby participate more fully in the banking system.
Of course, if Capital One does charge higher debit card transaction fees than four-party issuers, some merchants may choose to no longer accept its debit cards (and, if Capital One’s terms require merchants to accept all cards operating on its branded three-party network, also its credit cards). And if fewer merchants accept its cards, that will make the cards less attractive to consumers. Capital One will therefore have to balance such potential effects on merchants against the benefits to cardholders, just as Sears did in 1986 when it introduced Discover with lower than prevailing merchant fees in order to incentivize merchant acceptance.
From the perspective of merchants as a whole, the prospect of a larger proportion of consumers having bank accounts, and an even greater proportion paying by card rather than cash, should be attractive, given that card payments can result in increased sales (because consumers are able to spend more than they have in their wallet).[90] Meanwhile, having some consumers use debit cards rather than credit cards should also be attractive. As such, not only does it seem unlikely that many merchants would cease accepting Capital One cards, but it is also unlikely that Capital One switching its debit cards to Discover’s networks would cause net harm to social welfare.
From an antitrust perspective, it appears almost certain that, while some merchants may face higher costs of acceptance, this will be more than balanced by the increase in card-based transactions. Hence, there would be lower net costs for many merchants and an increase in consumer benefits arising from the rewards and other benefits the debit cards would now provide.
A similar issue lay at the heart of the U.S. Supreme Court’s decision in Ohio v. Amex:
Respondent… Amex… operate[s] what economists call a “two-sided platform,” providing services to two different groups (cardholders and merchants) who depend on the platform to intermediate between them. Because the interaction between the two groups is a transaction, credit-card networks are a special type of two-sided platform known as a “transaction” platform. The key feature of transaction platforms is that they cannot make a sale to one side of the platform without simultaneously making a sale to the other. Unlike traditional markets, two-sided platforms exhibit “indirect network effects,” which exist where the value of the platform to one group depends on how many members of another group participate. Two-sided platforms must take these effects into account before making a change in price on either side, or they risk creating a feedback loop of declining demand. Thus, striking the optimal balance of the prices charged on each side of the platform is essential for two-sided platforms to maximize the value of their services and to compete with their rivals.
Visa and MasterCard—two of the major players in the credit-card market—have significant structural advantages over Amex. Amex competes with them by using a different business model, which focuses on cardholder spending rather than cardholder lending. To encourage cardholder spending, Amex provides better rewards than the other credit-card companies. Amex must continually invest in its cardholder rewards program to maintain its cardholders’ loyalty. But to fund those investments, it must charge merchants higher fees than its rivals. Although this business model has stimulated competitive innovations in the credit-card market, it sometimes causes friction with merchants.[91]
Thus, the fact that some merchants may see their costs rise (slightly) as a result of the merger must be weighed against the significant benefits that accrue to consumers and other merchants.
Returning to the criteria by which the Federal Reserve and OCC are required to evaluate this merger, and in service of which this paper has been produced, (1) the convenience and needs of the communities to be served by the combined organization and (2) competition in the relevant markets, the forgoing analysis leads to the following conclusions:
Through these effects, Capital One may attract additional customers, especially those with low incomes or lower credit scores, thereby more effectively meeting the convenience and needs of the communities it serves. At the same time, and for largely the same reasons, it would arguably increase competition in most relevant markets and is unlikely substantially to diminish competition in any markets.
[1] Press Release, Capital One to Acquire Discover, Capital One (Feb. 19, 2024), https://investor.capitalone.com/news-releases/news-release-details/capital-one-acquire-discover.
[2] Press Release, Board of Governors of the Federal Reserve System & Office of the Comptroller of the Currency, Agencies Announce Public Meeting on Proposed Acquisition by Capital One of Discover; Public Comment Period Extended, Federal Reserve Board (May 14, 2024), https://www.federalreserve.gov/newsevents/pressreleases/other20240514a.htm; Press Release, Agencies Announce Public Meeting on Proposed Acquisition by Capital One of Discover; Public Comment Period Extended, Office of the Comptroller of the Currency (May 14, 2024), https://www.occ.gov/news-issuances/news-releases/2024/nr-ia-2024-50.html.
[3] See, Letter to the Honorable Michael Barr, Vice Chair of Supervision for the Board of Governors of the Federal Reserve System and Acting Comptroller Michael Hsu, Office of the Comptroller of the Currency from the Undersigned Members of the Congress of the United States, Office of Sen. Elizabeth Warren (Feb. 25, 2024), available at https://www.warren.senate.gov/imo/media/doc/2024.02.25%20Capital%20One%20Letter1.pdf.
[4] See, Letter to the Honorable Jerome Powell, et. al from the Undersigned Members of the U.S. House of Representatives Committee on Financial Services, House Financial Services Committee Democrats (Feb. 28, 2024), available at https://democrats-financialservices.house.gov/uploadedfiles/02.28_-_ltr_on_ibmr.pdf.
[5] See, Letter to Jonathan Kanter, Assistant Attorney General of the U.S. Department of Justice, Antitrust Division from Senator Josh Hawley, Office of Sen. Josh Hawley (Feb. 21, 2024), available at https://www.hawley.senate.gov/wp-content/uploads/files/2024-02/Hawley-Letter-to-Kanter-re-Capital-One-Discover-Merger.pdf.
[6] See, e.g., Julian Morris & Todd Zywicki, Regulating Routing in Payment Networks (ICLE White Paper 2022-08-17), available at https://laweconcenter.org/wp-content/uploads/2022/08/Regulating-Routing-in-Payment-Networks-final.pdf; Julian Morris, The Credit Card Competition Act’s Potential Effects on Airline Co-Branded Cards, Airlines, and Consumers (ICLE White Paper 2023-11-17), available at https://laweconcenter.org/wp-content/uploads/2023/11/CCCA-Airline-Rewards-Study-v4.pdf.
[7] The list of relevant criteria for consideration includes: the convenience and needs of the communities to be served by the combined organization; each insured depository institution’s performance under the Community Reinvestment Act; competition in the relevant markets; the effects of the proposal on the stability of the U.S. banking or financial system; the financial and managerial resources and future prospects of the companies and banks involved in the proposal; and the effectiveness of the companies and banks in combatting money laundering activities. See Joint Press Release, supra note 4; 12 U.S.C. § 1828(c).
[8] See, Federal Reserve Board, Insured U.S.-Chartered Commercial Banks That Have Consolidated Assets of $300 Million or More, Ranked by Consolidated Assets as of March 31, 2024, Federal Reserve Board (Mar. 31, 2024), https://www.federalreserve.gov/releases/lbr/current.
[9] See, Federal Reserve Bank of New York, Quarterly Report on Household Debt and Credit, 2023:Q4, Federal Reserve Board (Feb. 2024), https://www.newyorkfed.org/medialibrary/interactives/householdcredit/data/pdf/HHDC_2023Q4; 20 Bank Holding Companies With the Largest Credit Card Loan Portfolios, American Banker (Mar. 28, 2024), https://www.americanbanker.com/list/20-bank-holding-companies-with-the-largest-credit-card-loan-portfolios-at-the-end-of-q4.
[10] See Shahid Naeem, Capital One-Discover: A Competition Policy and Regulatory Deep Dive, American Economic Liberties Project (Mar. 2024), available at https://www.economicliberties.us/wp-content/uploads/2024/03/2024-03-20-Capital-One-Discover-Brief-post-design-FINAL.pdf.
[11] See Diana Moss, The Capital One Financial-Discover Financial Services Merger: A Test for the Biden Merger Agenda?, Progressive Policy Institute (Jun. 20, 2024), at 1, available at https://www.progressivepolicy.org/wp-content/uploads/2024/06/PPI-Capitol-One-Discover-Commentary.pdf.
[12] Application to the Board of Governors of the Federal Reserve System for Prior Approval for Capital One Financial Corporation to Acquire Discover Financial Services Pursuant to Section 3 of the Bank Holding Company Act and Section 225.15 of Regulation Y, Federal Reserve Board(Mar. 20, 2024), at 40, available at https://www.federalreserve.gov/foia/files/capital-one-application-20240320.pdf [hereinafter “Capital One Application”].
[13] See, New Sears Credit Card by Year-End, Chicago Tribune (Apr. 25, 1985), https://www.chicagotribune.com/1985/04/25/new-sears-credit-card-by-year-end.
[14] See Nancy Yoshihara, Sears Unveils Its New Credit Card: Multipurpose “Discover” to Get 1st Test Marketing in Fall, Los Angeles Times (Apr. 25, 1985), https://www.latimes.com/archives/la-xpm-1985-04-25-fi-12317-story.html.
[15] Id.
[16] See Todd J. Zywicki, The Economics of Payment Card Interchange Fees and the Limits of Regulation (ICLE Financial Regulatory Program White Paper Series, Jun. 2, 2010), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1624002.
[17] See Chicago Tribune, supra note 13.
[18] See Jack Caporal, Average Credit Card Processing Fees and Costs in 2024, the ascent, https://www.fool.com/the-ascent/research/average-credit-card-processing-fees-costs-america, (last updated Jun. 5, 2024), (noting that “Discover credit card processing fees have the lowest range, excluding outliers.”).
[19] See Eric Schmuckler, Playing Your Cards Right, Forbes (Dec. 28, 1987).
[20] See, Discover—Dawn of Discover, AdAge (Jan. 26, 1986), https://adage.com/videos/discover-dawn-of-discover/1241.
[21] See Frances Denmark, Discover CEO David Nelms Reinvents His Credit Card Firm, Institutional Investor (Dec. 28, 2011), https://www.institutionalinvestor.com/article/2bszspjc02cwjwn5f2pds/portfolio/discover-ceo-david-nelms-reinvents-his-credit-card-firm.
[22] Michael Weinstein, Bankers: DiscoverCard Has Not Hurt Business, American Banker (Mar. 7, 1988).
[23] Diners Club and MasterCard Finalize Alliance, The Payers (Sep. 27, 2004), https://thepaypers.com/payments-general/diners-club-and-mastercard-finalize-alliance–724076.
[24] See, e.g., The Story Behind The Card, Diners Club Int’l, https://www.dinersclubus.com/home/about/dinersclub/story (last accessed Jul. 17, 2024); Press Release, BMO Financial Group Announces Agreement to Acquire the Diners Club North American Franchise From Citigroup, BMO Financial Group (Nov. 24, 2009), https://newsroom.bmo.com/2009-11-24-BMO-Financial-Group-Announces-Agreement-to-Acquire-the-Diners-Club-North-American-Franchise-From-Citigroup.
[25] See Denmark, supra note 21.
[26] See Adam McCann, Market Share by Credit Card Network, WalletHub (May 9, 2024), https://wallethub.com/edu/cc/market-share-by-credit-card-network/25531.
[27] See Fred Ashton, Capital One’s Acquisition of Discover Could Inject Competition Into Payments Market, American Action Forum Insight (Feb. 29, 2024), at fig. 2, https://www.americanactionforum.org/insight/capital-ones-acquisition-of-discover-could-inject-competition-into-payments-market.
[28] Michelle Price, Exclusive: CapOne Tells Regulators Discover Deal will Boost Competition and Stability, Reuters (Mar. 21, 2024), https://www.reuters.com/markets/deals/capone-tells-regulators-discover-deal-will-boost-competition-stability-sources-2024-03-21.
[29] Capital One Financial Corporation, Capturing the Essence of Capital One: 1996 Annual Report 2-3 (1996), available athttps://investor.capitalone.com/static-files/d823fcd3-e1f1-439a-a34f-5296ef58b93c.
[30] See id. at 3, 5-6.
[31] Id. at 3.
[32] See David Morrison & Adrian Slywotzky, Off the Grid, Industry Standard (Oct. 23, 2000).
[33] See Andrew Becker, The Secret History of the Credit Card, Frontline (Nov. 23, 2004), https://www.pbs.org/wgbh/pages/frontline/shows/credit/more/battle.html.
[34] See Morrison & Slywotzky, supra note 32.
[35] Sheila Bair, How the Capital One/Discover Deal Could Boost Competition, Financial Times (May 31, 2024), https://on.ft.com/4640E6h.
[36] See Morrison & Slywotzky, supra note 32.
[37] See Zack Martin, Capital One Makes Big Push to Become a National Brand, Card Marketing (Dec. 2000).
[38] See Jon Prior, Capital One Keeps Closing Branches, Even as Rivals Open Them, American Banker (Jul. 1, 2019), https://www.americanbanker.com/news/capital-one-keeps-closing-branches-even-as-rivals-open-them.
[39] See Lukasz Drozd, Why Credit Cards Played a Surprisingly Big Role in the Great Recession, 6(2) Econ. Insights 10 (Mar. 2021), n. 12, https://fraser.stlouisfed.org/title/6149/item/604454?start_page=ii.
[40] Naomi Snyder, Capital One’s Secret to Success, Bank Director (Aug. 15, 2022), https://www.bankdirector.com/article/capital-ones-secret-to-success (Capital One “invented the secure credit card”); Larry Santucci, The Secured Credit Card Market, Federal Reserve Bank of Philadelphia(Nov. 2016), available at https://www.philadelphiafed.org/-/media/frbp/assets/consumer-finance/discussion-papers/dp16-03.pdf (“While we were unable to identify the first bank to issue a secured card, the innovation is believed to have occurred sometime in the late 1970s.”).
[41] See Alex Woodie, The Modernization of Data Engineering at Capital One, Datanami (Apr. 4, 2022), https://www.datanami.com/2022/04/04/the-modernization-of-data-engineering-at-capital-one.
[42] See, e.g., Sabrina Karl, Best High-Yield Savings Accounts of July 2024—Up to 5.55%, Investopedia, https://www.investopedia.com/best-high-yield-savings-accounts-4770633 (last updated Jul. 17, 2024), (listing Capital One and Discover among the highest-available interest rates for new accounts).
[43] See Anish Kapoor, Capital One-Discover Acquisition: Unpicking [sic] the Consumer and Competitive Benefits, LinkedIn.com (Apr. 15, 2024), available at https://www.linkedin.com/pulse/capital-one-discover-acquisition-unpicking-consumer-benefits-kapoor-53yge.
[44] Capital One itself lists “Combin[ing] Capital One’s scale in credit cards and banking with Discover’s vertically integrated global payments network” and “Enhanc[ing] Capital One’s ability to compete with the national’s largest banks in credit cards and banking” as the top two reasons for its “strategic rationale.” Investor Presentation, Capitol One & Discover (Feb. 20, 2024), at 4 https://investor.capitalone.com/static-files/cfa11729-0aec-43dc-b531-200e250c8413.
[45] See Eric Fruits, Justin (Gus) Hurwitz, Geoffrey A. Manne, Julian Morris, & Alec Stapp, Static and Dynamic Effects of Mergers: A Review of the Empirical Evidence in the Wireless Telecommunications Industry (OECD, DAF/COMP/GF(2019)13, Dec. 6, 2019), available at https://one.oecd.org/document/DAF/COMP/GF(2019)13/en/pdf.
[46] Id. at 17.
[47] Id. at 8.
[48] Id. at 3.
[49] Caitlin Mullin, Capital One Pledges to Give Discover’s Network a Boost, Payments Dive (Mar. 26, 2024), https://www.paymentsdive.com/news/capital-one-discover-acquisition-federal-reserve-occ-debit-credit-card-network-visa-mastercard/711385.
[50] Id.; see also, Leading Credit Card Issuers in the United States from 2007 to 2023, Based on Value of Transactions for Goods and Services,Statista (Feb. 2024), https://www.statista.com/statistics/1080768/leading-credit-card-issuers-usa-by-purchase-volume.
[51] See, e.g., Press Release, Sen. Dick Durbin, Durbin, Marshall Announce Hawley, Reed as New Cosponsors, Growing Support for Credit Card Competition Act, Office of Sen. Dick Durbin (Feb. 14 2024), https://www.durbin.senate.gov/newsroom/press-releases/durbin-marshall-announce-hawley-reed-as-new-cosponsors-growing-support-for-credit-card-comptition-act (arguing that “[f]or too long, the Visa-Mastercard duopoly alongside the Wall Street megabanks have price-gouged hardworking Americans with little-to-no oversight” and “[f]or years, Visa and Mastercard have taken advantage of their duopoly in the credit market to impose extreme fees on small merchants and retailers.”).
[52] Mary Ann Azevedo, When Foes Become Friends: Capital One Partners with Fintech Giants Stripe, Adyen to Prevent Fraud, TechCrunch (Jun. 5, 2024), https://techcrunch.com/2024/06/05/when-foes-become-friends-capital-one-partners-with-fintech-giants-stripe-adyen-to-prevent-fraud.
[53] Transcript of Conference Call Held by Capital One Financial Corporation and Discover Financial Services on February 20, 2024, Filed by Capital One Financial Corporation (Commission File No.: 001-13300), available at https://investor.capitalone.com/static-files/d7b64c07-9663-4b0a-b382-48792a04c148:
“So, on the debit side with the Discover Global Network, with the Pulse PIN debit network, along with their Discover signature debit network, it’s really well-positioned and in a strong position to just basically take our debit volume at this place and at this point, and we feel comfortable moving our entire business over there.” See also, supra note 49 (“Currently, Capital One’s debit cards run on Mastercard’s network, and all of that volume will move to Discover’s network, Capital One executives said Tuesday. Some portion of Capital One’s credit cards will move to Discover’s payment rails as well, Fairbank said. Capital One issues cards on both the Visa and Mastercard networks, with about 42% of the bank’s credit cards running on Visa and 58% on Mastercard, as of 2022, according to Bank of America Securities analysts.”.
[54] H.R.4173 – Dodd-Frank Wall Street Reform and Consumer Protection Act, s.1075(a)(3); Debit Card Interchange Fees and Routing; Final Rule, 76 Fed. Reg. 43,393-43,475, (Jul. 20, 2011).
[55] Todd J. Zywicki, Geoffrey A. Manne, & Julian Morris, Unreasonable and Disproportionate: How the Durbin Amendment Harms Poorer Americans and Small Businesses, Int’l Cntr For L. & Econ. (Apr. 25, 2017), available at https://laweconcenter.org/wp-content/uploads/2017/08/icle-durbin_update_2017_final-1.pdf.
[56] See, e.g., Benjamin S. Kay, Mark D. Manuszak, & Cindy M. Vojtech, Competition and Complementarities in Retail Banking: Evidence From Debit Card Interchange Regulation, 34 J. Fin. Intermediation 91, 92 (2018) (estimating losses of interchange income between $4.1-$6.5 billion); Vladimir Mukharlyamov & Natasha Sarin, Price Regulation in Two-Sided Markets: Empirical Evidence From Debit Cards (Dec. 2019), https://ssrn.com/abstract=3328579 (estimating $5.5 billion annual revenue loss to banks from interchange-fee reductions); Bradley G. Hubbard, The Durbin Amendment, Two-Sided Markets, and Wealth Transfers: An Examination of Unintended Consequences Three Years Later, SSRN (May 20, 2013), at 20, https://ssrn.com/abstract=2285105 (estimating annual revenue loss of $6.6 billion to $8 billion from the Durbin amendment).
[57] See Darryl E. Getter, Regulation of Debit Interchange Fees, Congressional Research Service (May 16, 2017), at 8. See also Electronic Payments Coalition, Out of Balance: How the Durbin Amendment Has Failed to Meet Its Promises 7 (Dec. 2018), available at https://www.electronicpaymentscoalition.org/wp-content/uploads/2018/12/EPC.DurbinStudiesPaper.pdf (Eliminating rewards, such as cash-back on purchases, is functionally equivalent to a price increase).
[58] Mark D. Manuszak & Krzysztof Wozniak, The Impact of Price Controls in Two-Sided Markets: Evidence From US Debit Card Interchange Fee Regulation (Bd. of Governors of the Fed. Res. Sys. Fin. & Econ. Discussion Series, Working Paper No. 2017-074, 2017); Mukharlyamov & Sarin, supra note 56.
[59] Mukharlyamov & Sarin, supra note 56.
[60] See Aly J. Yale, Everything You Need to Know About Banking with Capital One, Wall Street Journal (May 28, 2024), https://www.wsj.com/buyside/personal-finance/banking/capital-one-bank-review.
[61] See Blake Ellis, Wells Fargo, Chase, SunTrust cancel debit rewards program, CNN Money (Mar. 28, 2011), https://money.cnn.com/2011/03/25/pf/debit_rewards/index.htm (noting the move by major banks to cancel debit-card rewards in anticipation of the Durbin amendment going into effect); Richard Kerr, Where Have All the Rewards Debit Cards Gone?, The Points Guy (Jun. 24, 2015), https://thepointsguy.com/credit-cards/rewards-debit-cards-gone (describing the “slow death of debit cards that earn points and miles.”).
[62] See, e.g., Earn Cash Back Rewards with No Fees, Discover (2024), https://www.discover.com/online-banking/checking-account.
[63] Kalle Radage, Credit Card Fraud in 2023, Clearly Payments (Aug. 13, 2023), https://www.clearlypayments.com/blog/credit-card-fraud-in-2023.
[64] See, e.g., Discover Financial Jumps 7% After Agreeing with FDIC to Improve Consumer Compliance, Reuters (Oct. 2, 2023), https://www.reuters.com/business/finance/discover-financial-jumps-7-after-agreeing-with-fdic-improve-consumer-compliance-2023-10-02; David Lukic, The Discover Breach, Credit Card Companies Nightmare, ID Strong (Dec. 11, 2023), https://www.idstrong.com/sentinel/discover-breach-credit-card-companies-nightmare.
[65] EMV chips use a form of public-key infrastructure. The token is encrypted using the issuer’s public key and can only be decrypted using the issuer’s private key. After decrypting the token (technically, a cryptogram), the issuer can validate the transaction by checking its authenticity and integrity. If the token is validated successfully, the issuer authorizes the transaction. If the token cannot be validated, the transaction is declined.
[66] See Elint Chu, What Is New with EMV 3DS v.2.3?, EMVCo (Nov. 12, 2021), https://www.emvco.com/knowledge-hub/what-is-new-with-emv-3ds-v2-3.
[67] See, e.g., NuData: It’s Time for Businesses to Replace the Old ‘New Normal’ With a New One, PYMNTS (Jun. 30, 2021), https://www.pymnts.com/news/payments-innovation/2021/nudata-time-businesses-replace-old-new-normal; Chris Burt, Smartmetric CEO Claims Progress Towards American Biometric Payment Card Launch, Biometric Update (Jul. 18, 2022), https://www.biometricupdate.com/202207/smartmetric-ceo-claims-progress-towards-american-biometric-payment-card-launch.
[68] See Jim Bruene, Capital One Launches SureSwipe for Gesutre-Based Mobile Login, Finovate (Nov. 11, 2013), https://finovate.com/capital_ones_gesture-based_mobile_login_sureswipe.
[69] Capital One Patent Looks To Bring Voice Recognition Technology To Mobile Payments, CBInsights (Oct. 13, 2020), https://www.cbinsights.com/research/capital-one-patent-voice-recognition-tech-mobile-payments.
[70] See supra note 52 and accompanying text.
[71] See supra notes 3-5 and accompanying text.
[72] See Federal Reserve Board, supra note 8.
[73] Id.
[74] See Capital One Application, supra note 12, at 39.
[75] See Federal Reserve Board, supra note 8.
[76] See Capital One Application, supra note 12, at 39-40.
[77] CFPB provides the following definitions: superprime (800 or greater), prime plus (720 to 799), prime (660 to 719), near-prime (620 to 659), subprime (580 to 619), and deep subprime (579 or less). Consumer Financial Protection Bureau, The Consumer Credit Card Market 12 (Oct. 2023), available at https://files.consumerfinance.gov/f/documents/cfpb_consumer-credit-card-market-report_2023.pdf.
[78] Naeem, supra note 10, at 17.
[79] Haelim Anderson, Paul Calem, & Benjamin Gross, Is the Subprime Segment of the Credit Card Market Concentrated? Bank Policy Institute(May 31, 2024), https://bpi.com/is-the-subprime-segment-of-the-credit-card-market-concentrated.
[80] See Fair Isaac Corporation, FICO Research: Consumer Credit Score Migration (2018), https://www.fico.com/en/latest-thinking/white-paper/fico-research-consumer-credit-score-migration.
[81] CFPB, supra note 77, at 16—17.
[82] See Anderson, Calem, & Gross, supra note 79, at Panel C.
[83] Id. at Conclusion.
[84] Becker, supra note 33 (“By identifying lower-risk individuals in high-risk groups, Capital One was able to market to reliable consumers other companies wouldn’t touch, says [Chris] Meyer [CEO of Monitor Networks]. In just six years, Capital One became the sixth-largest credit card issuer in the country. “When others were attacking the market with blunt instruments, Capital One used a scalpel,” says Meyer.”).
[85] Snyder, supra note 40 (“Sanjay Sakhrani, an equity analyst and managing director at the investment bank Keefe, Bruyette & Woods, says the bank focuses its efforts on the most profitable risk-adjusted return segments. “I think they’ve done a very effective job [of] underwriting and managing risks inside of the subprime population,” he says. The bank starts by offering those customers low credit lines and graduates them over time as they demonstrate their credit worthiness.”).
[86] See Drozd, supra note 39.
[87] See Snyder, supra note 40.
[88] See, e.g., Ian McGroarty, CFI in Focus: Secured Credit Cards, Federal Reserve Bank of Philadelphia (Sep. 2019), at 1-2, available athttps://www.philadelphiafed.org/-/media/frbp/assets/consumer-finance/articles/secured-credit-cards.pdf.
[89] Id. at 6-7.
[90] Sumit Agarwal, Wenlan Qian, Yuan Ren, Hsin-Tien Tsai, and Bernard Yeung, Mobile Wallet and Entrepreneurial Growth, AEA Papers and Proceedings, 109:48–53 (2019); David Bounie and Youssouf Camara, Card-Sales Response to Merchant Contactless Payment Acceptance, Journal of Banking & Finance, Vol. 119, issue C. (2020).
[91] Ohio v. American Express Co., 138, S.Ct. 2274, 2276-77, 585 U.S. 529 (2018).
ICLE Issue Brief Executive Summary In the 36 years since California voters moved to overhaul the state’s insurance regulatory system with Proposition 103, the state’s insurance market has . . .
In the 36 years since California voters moved to overhaul the state’s insurance regulatory system with Proposition 103, the state’s insurance market has struggled to keep pace with national trends and product innovations. As we have previously detailed, the rate-intervenor system created by Prop 103 has been among the most significant impediments to the efficient and effective functioning of the insurance market.
In practice, the intervenor process has proven both costly and time-consuming, with a five-year average filing delay of 236 days for homeowners insurance and 226 days for auto insurance. Such delays in rate filings make it more difficult for companies to change rates. Indeed, from 2018 to 2022, California ranked 49th in the number of homeowners-insurance rates filed, and 50th in the number of auto-insurance rates filed.
In addition, the state and the California Department of Insurance has for too long failed to exercise proper oversight of rate intervenors. The process has been dominated by a small handful of consumer groups—with the most significant participating organization founded by Prop 103’s author—that have rarely been called to task to prove that they are making the “substantial contribution” to the process required under the text of the law.
This issue brief details the form, function, and questionable value proposition of the rate-intervenor system and how it has served to render the Prop 103 rating system slow, imprecise, and inflexible. It also examines recent reform proposals to make the intervenor system more transparent and functional.
California voters in November 1988 approved Proposition 103, the “Insurance Rate Reduction and Reform Act.” Authored by Harvey Rosenfield of the Santa Monica-based Foundation for Taxpayer and Consumer Rights (now known as Consumer Watchdog) and sponsored by Rosenfield’s organization Voter Revolt, Prop 103 carried narrowly with 51.1% yes votes to 48.9% against.[1]
Prop 103’s stated purpose was “to protect consumers from arbitrary insurance rates and practices, to encourage a competitive insurance marketplace.”[2] Rate increases and decreases became subject to the prior approval of the elected insurance commissioner, replacing the “open competition” system that had previously prevailed for 40 years under the McBride-Grunsky Insurance Regulatory Act of 1947, which required only that insurers submit rate manuals to the California Department of Insurance (CDI).[3]
Under Prop 103, public hearings are mandatory for personal lines increases of more than 6.9% and commercial lines increases of more than 14.9%, while others are at CDI’s discretion. The law created a role at these hearings for “public intervenors,” who are empowered to file objections on behalf of consumers, with fees to be paid by the applicant insurance company. Intervenors are granted petitions to intervene, as a matter of right, on any rate filing.
Prop 103 authorizes intervenors who participate in rate filings to recover costs, expenses, and attorneys’ fees from insurers, who in turn can pass those costs on to consumers.[4] Individuals or organizations seeking to participate in the intervenor process must first apply for a finding of eligibility to seek compensation with the Office of the Public Advisor.[5] Applications for eligibility must include detailed corporate records, an accounting of consumer-protection activities, and disclosure of funding sources.
A finding of eligibility grants the individual or organization authority to petition to intervene in rate applications or investigatory or regulatory hearings involving property/casualty insurance, pending a ruling from CDI granting intervention. To obtain such a ruling, the intervenor must demonstrate that it can present relevant issues, evidence, or arguments that are separate and distinct from those already known by CDI. When a proceeding has completed, the intervenor submits a request for an award of compensation demonstrating that its participation yielded relevant, credible, and nonfrivolous information that the department would not otherwise have.[6] Compensation may not exceed “the prevailing rate for comparable services in the private sector in the Los Angeles and San Francisco Bay Areas … for attorney advocates, non-attorney advocates, or experts with similar experience, skill and ability.”[7]
The intervenor process has proven both costly and time-consuming. According to CDI data, since 2003, intervenors have been paid $23,267,698.72, or just over $1 million annually, for successfully challenging 177 filings.[8] CDI currently publishes quantitative data concerning intervenor compensation and rate differentiation in intervenor proceedings.[9] But while this is helpful in conveying the scope of intervenor efforts, the data arguably fail to capture the value actually provided by intervenors in the ratemaking process.
A major reason that the intervenor system has been so disruptive is that CDI has not historically enforced Prop 103’s “sufficient” pleading requirements. For instance, intervenors can use generic criticisms of a carrier’s trend and loss development copied and pasted from previous petitions, without any requirement to plead application-specific arguments based upon the intervenor’s review of the data. The carrier instead bears the burden of proof to justify what’s in a filing, leaving the intervenor with no pleading burdens at all.
Since its inception, the intervenor program has been dominated by Consumer Watchdog, whose founder Harvey Rosenfield authored Prop 103. But the degree to which other organizations have taken part in the process has ebbed and flowed over time. As Daniel Schwarcz noted in 2012:
Until about 2004, a diverse range of organizations intervened in rulemaking and rate hearings, including organizations like the Southern Christian Leadership Conference, Public Advocates Group, Consumer Union, Voter Revolt, and a handful of private citizens and attorneys. In recent years, however, a single organization – Consumer Watchdog (“CW”) – has become the sole significant user of the intervention process, particularly with respect to rate hearings. In fact, CW is the sole recipient of forty-two of the sixty-six awards made since 2003, and the only organization to receive any reimbursement since 2007. During that period, CW is also, with a single exception, the only party to receive compensation for intervening in rate applications.[10]
During the five-year period from 2007-2012 when Consumer Watchdog was the only organization to participate in the intervenor program, it collected more than $6.2 million in fees.[11] In July 2012, in response to concerns raised by lawmakers that Consumer Watchdog was dominating the process, then-Insurance Commissioner Dave Jones appointed enforcement attorney Ed Wu to serve as a public advisor to groups seeking to participate in the intervenor process.[12]
Between 2013 and today, CDI deemed four consumer organizations (Consumer Watchdog, the Consumer Federation of California Education Foundation, the National Asian-American Coalition, and United Policyholders) eligible for compensation as intervenors.[13] In addition, four individuals (Anthony Manzo, Andrea Stevenson, Donald P. Hilla, and John Metz) and a trio of plaintiffs in a lawsuit against Farmers Insurance (Roger Harris, Duane Brown, and Brian Lindsey) have also been found eligible for compensation as rate intervenors;[14] to date, however, none of the individual intervenors has been awarded compensation by CDI.
Table 1 details annual compensation totals for the four eligible consumer organizations from 2013 to 2023.
SOURCE: California Department of Insurance[15]
As is obvious from Table 1, Consumer Watchdog remains by far the most active intervenor, taking 87% of the $12.2 million in compensation awarded over the past decade.
The intervenor process has also contributed to California having the second-most time-consuming rate-approval system in the country, behind only Colorado, with a five-year average filing delay of 236 days for homeowners insurance and 226 days for auto insurance.[16]
As originally presented to California voters, Prop 103 proposed that insurers’ rate filings would be deemed accepted if no action were taken by the CDI for 60 or 180 days.[17] Indeed, Prop 103 included this “deemer” provision because a reasonable speed-to-market for insurance products also protects consumers.
The law’s deemer provision has been effectively rendered moot in practice because, as a matter of course, the CDI requests that firms waive the deemer. If the deemer is not waived, the CDI has two options: approve the rate or issue a formal notice of hearing on the rate proposal. Because the CDI is unable to complete timely review of filings within the deemer period, it always elects to move to a rate hearing. In effect, CDI has turned every rate filing without a deemer waiver into an “extraordinary circumstance.”[18]
In practice, it has proven exceedingly challenging for petitioners to navigate the manner in which rate hearings—the nominal guarantors of due process—are conducted. The administrative law judges (ALJs) that oversee these proceedings are housed within the CDI. The hearings themselves take a broad view of relevance that drive up the cost of participation. Upon ALJ resolution, the commissioner can accept, reject, or modify the ALJ’s finding. There is little practical upside for an insurer to move to a hearing against the CDI.
Insurers are therefore faced with a starkly practical choice. One option is to waive their right to timely review of rates, and hope that they gain approval in, on average, six months. The alternative is to move to a formal hearing and reconcile themselves with the fact that approval, if forthcoming, will take at least a year. The system of due process originally contemplated by Prop 103 simply bears no relationship with the system as it operates today.
In recent months, an accelerating insurance-availability crisis and the announced exits of several of the state’s largest homeowners insurers have forced California leaders to rethink the ossified Prop 103 system. The proximate cause of the crisis has primarily been historically costly wildfires, and Prop 103’s inflexibility to allow insurers to adjust rates appropriately. In 2017 and 2018 alone, for example, California homeowners insurers posted a combined underwriting loss of $20 billion, more than double the total combined underwriting profit of $10 billion that the state’s homeowners insurers had generated from 1991 to 2016.[19]
While the highest-profile of the proposed reforms would address longstanding regulatory interpretations of Prop 103 that barred insurers from considering the cost of reinsurance in their rate filings or from using the output of catastrophe models to craft forward-looking loss estimates, policymakers have also turned their attention to ways to reform the intervenor process.
In September 2023, Gov. Gavin Newsom announced an emergency executive order to stabilize the state’s rapidly deteriorating market for property insurance. The order directed Insurance Commissioner Ricardo Lara to take “swift regulatory action to strengthen and stabilize California’s marketplace,” including by implementing changes to “[i]mprove the efficiency, speed, and transparency of the rate approval process.”[20]
For his part, Commissioner Lara announced an emergency response plan that called for:
Improving rate filing procedures and timelines by enforcing the requirement for insurance companies to submit a complete rate filing, hiring additional Department staff to review rate applications and inform regulatory changes, and enacting intervenor reform to increase transparency and public participation in the process …[21]
In May 2024, Newsom followed up with a “trailer” bill attached to the state’s 2024-2025 budget that would require the California Department of Insurance to respond to rate requests from insurers within 120 days and, if an insurer requests an average rate hike of more than 7%, to provide insurers with a suggested rate within that same time period.[22]
In essence, the proposal would amount to restoring the “dead letter” deemer provisions of Prop 103. Such reforms are crucial, as California’s sluggish regulatory system appears to be getting slower over time. The annual average number of days between filing and resolution of rate changes for homeowners insurance in California was 157 days from 2013 to 2019; from 2020 to 2022, the average delay increased to 293 days.[23]
These reforms are welcome. CDI could bolster them by committing, as a matter of administrative policy, to exercise its discretion not to convene public hearings on filed rate changes of less than 7% for personal lines or 15% for commercial lines. Such hearings add expense, administrative burden, and delays to very modest changes in product offerings. In particular, if a filing is made on the basis of least-inflationary or least-aggressive loss-development assumptions, CDI should undertake a light-touch review focused on rate sufficiency to expedite the approval process. This approach would have the benefit of increasing both the predictability and speed of the ratemaking process.
Questions long have been raised about the degree to which Consumer Watchdog has abided regulatory mandates that intervenors’ compensation and attorney and advisor fees are reasonable. Indeed, circa 2012, the group inspired a website called ConsumerWatchdogWatch.com, launched by a former chief of staff to then-Assembly Speaker Fabian Nunez and former press secretary to then-Gov. Gray Davis, that accused it of being “a ‘pay to play’ organization that generates millions of dollars for itself in fundraising schemes without revealing its special interest donors.”[24]
Of particular interest is the degree to which a significant portion of the 501(c)3 organization’s revenues flow to just a handful of contractors. According to the organization’s Form 990 filings with the Internal Revenue Service, over the 15 years from 2008 to 2022, Consumer Watch paid Rosenfield $6.8 million for legal and professional services, and an additional $3.9 million to Freehold, N.J.-based actuarial firm AIS Risk Consultants Inc.[25] Over that same period, Consumer Watchdog President Jamie Court earned $4.7 million.[26] Together, Rosenfield, Court, and AIS took about 28% of the $54 million in total revenue the organization received over those 15 years.[27]
The department and its ALJs have at times questioned the quality of Consumer Watchdog’s contributions to the process. As Schwarcz has noted:
CW’s scattershot approach has its costs. ALJs often regard its positions with skepticism – and occasionally, with hostility. For example, one ALJ dismissed the organization’s actuarial work as being “without merit,” saying that its arguments were “deficient and not credible.” Another said that CW’s testimony “at the least, is careless, and may be dodgier than that.”[28]
The organization had nonetheless enjoyed a lengthy streak of being renewed for eligibility to participate as a rate intervenor. In October 2023, however, Commissioner Lara denied a Consumer Watchdog petition to intervene in a rate filing by Liberty Insurance Corp., citing that the organization had submitted a “conclusory” finding that Liberty’s filed rate indication was inflationary and that the group “failed to meet its burden of proof with respect to the actuarial soundness of the selected trend factors and trend data period used.”[29] Moreover, Lara contended on separate contentions in the filing that Consumer Watchdog did “not plead any specific issue, but instead, holds open the possibility that an issue might arise in the future.”[30]
That denial would not be the last. In June 2024, Lara denied a pair of Consumer Watchdog petitions to intervene—in filings by USAA and State Farm in which the group sought $245,175 and $227,175 of compensation, respectively—with the commissioner declaring in both orders that the group’s proposed budget was “not supported by any documentation, exhibits, an attestation or even a mere statement that the hourly rates it contained did not exceed market rates.”[31]
Also in June, Lara delayed approval of Consumer Watchdog’s eligibility petition to continue to serve as an intervenor, on grounds that he could not yet determine whether its submission of documentation about its members, board of directors, and funding sources, and its required showing that it “represents the interests of consumers” were complete.[32] Given the delay, Consumer Watchdog’s existing eligibility determination expired July 12, 2024. Lara noted in his order that he would issue a decision in the matter no earlier than Aug. 2, 2024.[33]
The department’s recent posture of enhanced skepticism toward the value provided by rate intervenors has not been limited to Consumer Watchdog. In April 2024, the department initially denied a petition to intervene filed by the Consumer Federation of California Education Foundation on grounds that it cited “no specific issues to be raised or positions to be taken on any issue” in a proceeding concerning the department’s proposed regulatory action regarding complete property/casualty rate applications.[34]
These recent developments raise hope that the department might exercise its discretion to reduce and sometimes reject fee submissions due to the lack of significant or substantial contribution. The department has long rubber-stamped fee requests, thereby creating incentives for unnecessary and costly delays in reviews and in actuarially justified rate increases.
But while this recent posture is to be welcomed, the concern is that it could be limited to ad hoc interventions that fall by the wayside when the current crisis abates. More lasting change in regulatory procedure is essential if California is to better understand the value that intervenors offer, and to ensure that intervenor engagement is both efficient and effective.
One way to change the system for the better would be to find that a carrier’s compliance with the complete-rate-application requirements shifts the burden to the intervenor for why an actuarial selection is wrong. That would require the intervenor to actually perform analysis in the first 45 days and present their data and calculations. The requirements to demonstrate a “substantial contribution” should also be tightened. To be eligible for compensation, petitioners should be required to show nonduplicative contributions or novel arguments that the CDI wouldn’t otherwise make. Where the intervenor merely repeats the same critiques as CDI, it should not trigger payments.
Another useful change would be to return to the pre-2006 definition of when a “proceeding” begins. Under the original iteration of intervenor regulations, it commenced upon appointment of an ALJ for an adversarial proceeding. Intervenors were not permitted to participate in pre-hearing discussions between an insurer and the CDI; they could only earn compensation for disputes that proceeded to a hearing. Returning to that original definition would reduce disruptions that hold up filings.
Similarly, CDI and the Legislature should examine how the definition of “market rate” is applied to intervenor compensation.[35] The state code currently requires that compensation may not exceed “the prevailing rate for comparable services in the private sector in the Los Angeles and San Francisco Bay Areas … for attorney advocates, non-attorney advocates, or experts with similar experience, skill and ability.” But given that the Santa Monica-based Consumer Watchdog has long been effectively the only provider of “comparable services” in this space, the question must be raised whether it is effectively setting the very billing benchmark against which its own compensation requests are judged. Moreover, given that Consumer Watchdog’s single-largest outside contractor is based in New Jersey, CDI should interrogate whether the out-of-state rates AIS charges Consumer Watchdog for its actuarial services actually comport with prevailing in-state rates.
The qualitative contributions made by intervenors are also obscured by the fact that none of their filings appear publicly on the National Association of Insurance Commissioners’ (NAIC) System For Electronic Rates and Forms Filing (SERFF). Not only is this an aberration relative to other proceedings before the CDI, but there could be significant value in getting greater transparency from the intervenor process, given the delays and direct costs related to intervention.
The CDI has in the past year established a webpage that posts some information on intervenors’ filings and participation, but this requires observers to perform manual checks, rather than the far simpler option of checking SERFF. Allowing the Legislature and the public to assess the substantive value of intervenor contributions would ensure not only substantial due-process protections for filing entities, but would also guarantee that consumers are afforded a high level of representation in proceedings. For instance, such transparency would function as a guarantor that intervenor filings are not otherwise duplicative of CDI efforts. It would therefore allow the public to assess whether intervenors are diligent in efforts putatively made on their behalf.
[1] Steve Geissinger, Californians Approve Auto Insurance Cuts, Insurer Files Lawsuit, Associated Press (Nov. 9, 1988).
[2] Text of Proposition 103, Consumer Watchdog (Jan. 1, 2008), https://consumerwatchdog.org/insurance/text-proposition-103.
[3] Cal. Ins. Code §1850-1860.3.
[4] Cal. Ins. Code §1861.01-1861.16.
[5] Cal. Code of Regulations, Title 10, Ch. 5, §2623.2.
[6] Cal. Code of Regulations, Title 10, Ch. 5, §2623.5.
[7] Cal. Code of Regulations, Title 10, Ch. 5, Art. 13, §2661.1(b).
[8] Data are drawn from Informational Report on the CDI Intervenor Program, California Department of Insurance, available at https://www.insurance.ca.gov/01-consumers/150-other-prog/01-intervenor/report-on-intervenor-program.cfm (last visited Jul. 17, 2024).
[9] Informational Report on the CDI Intervenor Program, California Department of Insurance, https://www.insurance.ca.gov/01-consumers/150-other-prog/01-intervenor/report-on-intervenor-program.cfm (last accessed Aug. 16, 2023)
[10] Daniel Schwarcz, Preventing Capture Through Consumer Empowerment Programs: Some Evidence from Insurance Regulation, Minnesota Legal Studies Research Paper No. 12-06 (Jan. 11, 2012).
[11] Don Jergler, California Legislator Calls for Hearing on Intervenor Fees, Insurance Journal (May 17, 2012), https://www.insurancejournal.com/news/west/2012/05/17/247939.htm#.
[12] Jones Names New Public Advisor To Would be Intervenors, Insurance Journal (Jul. 18, 2012), https://www.insurancejournal.com/news/west/2012/07/18/256128.htm#.
[13] Requests for and Findings of Eligibility to Seek Compensation, Received Since January 1, 2013, California Department of Insurance, available at https://www.insurance.ca.gov/01-consumers/150-other-prog/01-intervenor/upload/Requests-for-and-Findings-of-Eligibility-7-11-24.pdf (last updated Jul. 11, 2024)
[14] Id.
[15] Total Compensation Awarded to Intervenor, California Department of Insurance, available at https://www.insurance.ca.gov/01-consumers/150-other-prog/01-intervenor/upload/Total-Compensation-2013-2023_7-16-24.pdf (last updated Jul. 16, 2024).
[16] Lawrence Powell, R.J. Lehmann, & Ian Adams, Rethinking Prop 103’s Approach to Insurance Regulation, Connecticut Insurance Law Journal (forthcoming), available at https://laweconcenter.org/wp-content/uploads/2023/11/Rethinking-Prop-103s-Approach-to-Insurance-Regulation-2.pdf.
[17] Cal. Ins. Code §1861.05.
[18] Cal. Ins. Code §1861.065(d).
[19] Eric J. Xu, Cody Webb, & David D. Evans, Wildfire Catastrophe Models Could Spark the Change California Needs, Milliman (Oct. 2019), available at https://fr.milliman.com/-/media/milliman/importedfiles/uploadedfiles/wildfire_catastrophe_models_could_spark_the_changes_california_needs.ashx.
[20] Press Release, Governor Newsom Signs Executive Order to Strengthen Property Insurance Market, Office of Gov. Gavin Newsom (Sep. 21, 2023), https://www.gov.ca.gov/2023/09/21/governor-newsom-signs-executive-order-to-strengthen-property-insurance-market.
[21] Press Release, Commissioner Lara Announces Sustainable Insurance Strategy to Improve State’s Market Conditions for Consumers, California Department of Insurance (Sep. 21, 2023), https://www.insurance.ca.gov/0400-news/0100-press-releases/2023/release051-2023.cfm.
[22] 2024-25 Budget – Streamlined Review of Pending Insurance Filings, California Department of Finance, available at https://esd.dof.ca.gov/trailer-bill/public/trailerBill/pdf/1140 (last updated May 28, 2024).
[23] Powell, Lehmann, & Adams, supra note 16.
[24] Press Release, ConsumerWatchdogWatch.com Launched to Expose ConsumerWatchdog.org, ConsumerWatchdogWatch.com (Feb. 8, 2012), https://www.prnewswire.com/news-releases/consumerwatchdogwatchcom-launched-to-expose-consumerwatchdogorg-138926074.html.
[25] Consumer Watch OMB No. 1545-0047, Form 990 Return of Organization Exempt from Income Tax (2008-2022).
[26] Id.
[27] Id.
[28] Schwarcz, supra note 10 (citations omitted).
[29] Ricardo Lara, Order Denying Consumer Watchdog’s Petition to Intervene with Leave to Amend, California Department of Insurance (Oct. 3, 2023), available at https://www.insurance.ca.gov/01-consumers/150-other-prog/01-intervenor/upload/Order-Denying-CW-Petition-to-Intervene_Liberty-Insurance-Petition_10-2023.pdf.
[30] Id.
[31] Ricardo Lara, Amended Order Denying Consumer Watchdog’s Petition to Intervene, California Department of Insurance (Jun. 25, 2024), available at https://www.insurance.ca.gov/01-consumers/150-other-prog/01-intervenor/upload/AMENDED-ORDER-DENYING-CW-S-PETITION-TO-INTERVENE-RE-SFMAIC-RULE-FILE-NO-24-788.pdf; Ricardo Lara, Order Denying Consumer Watchdog’s Petition to Intervene, California Department of Insurance (Jun. 18, 2024), available at https://www.insurance.ca.gov/01-consumers/150-other-prog/01-intervenor/upload/Order-Denying-CW-Petition-to-Intervene-in-United-Services-Auto-Association-Garrison-and-USAA-Casualty-24-722-723-744.pdf.
[32] Ricardo Lara, Order Concerning Consumer Watchdog’s Request for Finding of Eligibility to Seek Compensation, California Department of Insurance (Jun. 19, 2024), available at https://www.insurance.ca.gov/01-consumers/150-other-prog/01-intervenor/upload/ORDER-CONCERNING-CW-REQUEST-FOR-FINDING-OF-ELIGIBILITY-TO-SEEK-COMPENSATION-IE-2024-0002.pdf.
[33] Id.
[34] Ricardo Lara, Order Denying Consumer Federation of California Education Foundation’s Petition to Participate in the Proposed Regulatory Action Regarding Complete Property and Casualty Rate Applications, California Department of Insurance (Apr. 10, 2024), available at https://www.insurance.ca.gov/01-consumers/150-other-prog/01-intervenor/upload/ORDER-DENYING-CFCEF-S-PETITION-TO-PARTICIPATE-IN-THE-PROPOSED-REGULATORY-ACTION-REG-2019-00025.pdf.
[35] Supra note 7.
Popular Media Financial valuation is a cornerstone of modern commercial litigation, influencing outcomes across substantive areas of legal dispute, from bankruptcy to tax and corporate law. However, . . .
Financial valuation is a cornerstone of modern commercial litigation, influencing outcomes across substantive areas of legal dispute, from bankruptcy to tax and corporate law. However, its ubiquity comes with substantial challenges for the judiciary. Conventional approaches to valuation, including discounted cash flow, comparable company, and comparable transactions analyses, leave open substantial areas of discretion to be exploited by economic experts. In our article, we argue that these “expert degrees of freedom” generate inconsistent and overly subjective valuations, with expert reports regularly diverging by orders of magnitude, to the frequent frustration of generalist judges. Using Monte Carlo simulations and a case example, our paper demonstrates the benefits of using contemporary statistical learning techniques to increase the precision of financial valuation while reducing this variability and expert bias.
Read the full piece here.
Presentations & Interviews ICLE Chief Economist Brian Albrecht was a guest on the Qualified Opinions podcast to discuss whether inflation is really the product of greed, whether greater . . .
ICLE Chief Economist Brian Albrecht was a guest on the Qualified Opinions podcast to discuss whether inflation is really the product of greed, whether greater economic means equals less incentive for competition, and what the right approach to antitrust policy should be. Audio of the full episode is embedded below.
Popular Media Competition benefits consumers, not just through lower prices and better quality, but also by protecting them against fraudulent practices. Clear-eyed government regulation can promote competition . . .
Competition benefits consumers, not just through lower prices and better quality, but also by protecting them against fraudulent practices. Clear-eyed government regulation can promote competition and consumer protection by stomping out fraudulent and deceptive practices as well as facilitating the flow of accurate, easy-to-understand information. But what happens when the government is the source of bad information and uses that to promote specious claims that competition has “failed”? In the case of the Consumer Financial Protection Bureau, another round of misleading economic analysis is being used to justify further intrusions on market competition that could confuse consumers and lead to worse regulation.
Scholarship Abstract Decentralized Finance (DeFi) on Ethereum lacks a clear legal framework akin to what exists in traditional financial markets, leading to uncertainty for traders, intermediaries, . . .
Decentralized Finance (DeFi) on Ethereum lacks a clear legal framework akin to what exists in traditional financial markets, leading to uncertainty for traders, intermediaries, and other market participants regarding their protections, responsibilities, and risk exposures. Key concepts like what constitutes a “transaction,” who serves as a transaction counterparty, and what duties are owed remain undefined. This paper aims to clarify the legal journey of Ethereum transactions, focusing on the stages of trade instruction and execution. We examine the complex technical processes and actors involved, highlight areas where end-user expectations may be violated, discuss potential sources of legal liability, and explore whether certain DeFi activities like DEX trading should be governed by contract law. The paper assesses various parties, including validators, DEX liquidity providers, and smart contracts themselves, as potential legal counterparties to a DeFi trader. Based on this analysis, we provide recommendations for the development of a legal framework to enhance certainty and efficiency in DeFi markets. Establishing clear rules around trade instruction, execution, and liability allocation would enable more accurate risk assessment, support market participation and liquidity, and facilitate the healthy development of the DeFi ecosystem.
ICLE Issue Brief Abstract Once the jurisdiction that most clearly embraced a market-led approach to open banking, the United States appears on the verge of shifting to a . . .
Once the jurisdiction that most clearly embraced a market-led approach to open banking, the United States appears on the verge of shifting to a regulator-driven regime, with mandated sharing of financial data. More specifically, the U.S. Consumer Financial Protection Bureau (CFPB), relying on Section 1033 of the Dodd-Frank Act, recently proposed rules governing “personal financial data rights.” The rulemaking appears to follow the lead of the European Union (EU), which has long been at the forefront of government-led open banking. This paper seeks to analyze the CFPB proposal through the prism of the EU experience. A review of the EU’s regulatory framework, and particularly its implementation in the United Kingdom, may offer useful insights about the challenging tradeoffs posed by open banking, and thus permit an assessment of whether the CFPB proposal would add value, or simply represent an unnecessary regulatory burden
Following instructions laid out by President Joe Biden in his 2021 executive order on “Promoting Competition in the American Economy,”[1] the U.S. Consumer Financial Protection Bureau (CFPB) in October 2023 promulgated a “Personal Financial Data Rights” rulemaking to facilitate the portability of consumer banking and financial data.[2] The proposal would activate a to-date dormant provision of Section 1033 (the Consumer Financial Protection Act) of the Wall Street Reform and Consumer Protection Act of 2010 that was intended to accelerate a shift toward so-called “open banking.”[3] Open banking—a term that, in the United States, is frequently used to encompass “open finance” more broadly—refers to a financial-services environment built on interoperability and data-driven services that allows customers to leverage their transaction and financial data, and imposes on financial institutions a duty to share such data, on customers’ request, with third-party providers (TPPs).
Under open banking, financial institutions’ customers gain effective control of their data, as well as the opportunity to benefit from more competitive services enabled by the application of technological innovation to banking and finance (“fintech”). Given access to, and the ability to process, large troves of data (including nonfinancial data—e.g., digital footprints), fintech-enabled products can serve to promote financial inclusion, mitigate consumers’ unwillingness or inability to switch among firms, and help financial consumers to make informed choices and to shop around for the most convenient deals.[4] Open banking is therefore broadly expected to generate substantial benefits for businesses, consumers, and the economy as a whole.
Alongside those opportunities, however, financial innovation also poses several new concerns about consumer protection. Notably, the systematic digitization of financial transactions introduces potential for discrimination, manipulation, and exploitation of vulnerable customers.[5] Considering both consumers’ generally low levels of digital and financial literacy, and the opaque nature of algorithmic decisionmaking, they could be forced to make exceedingly complex choices among tradeoffs, and may be exposed to novel privacy and security risks. Even in cases of truly informed consent, the consumer-welfare impact of the enhanced fintech competition enabled by data sharing could be ambiguous.[6] Further, the emergence of new participants in the delivery of banking and financial services may negatively affect both competition and the financial system’s stability.
For all these reasons, designing a regulatory framework fit for purpose requires sensitive policy decisions about common standards for customer data and technical interfaces; solutions to allow customers to manage data permissions; eligibility rules and requirements for third parties seeking access to data; and the role of data aggregators.
The EU and UK have been at the forefront of the open-banking movement, having inspired other countries to follow their direction (e.g., Australia, Brazil, India, Mexico, Singapore). Those two jurisdictions are also currently evaluating proposals to extend their open-banking regulatory frameworks to “open finance” more broadly. A comparative analysis of the approaches adopted and models developed the EU and UK would therefore aid U.S. policymakers looking to strike the proper balance in the promises and perils of open banking.[7] Among the notable lessons to draw from the EU and UK experience include how those jurisdictions have sought to adopt a harmonized application programming interface (API) standard; to facilitate data access and create incentives to develop high-quality APIs; to define a regulatory framework for access to financial-information data; and whether to make banking and financial data available to nonfinancial companies (in particular, to so-called “Big Tech” platforms).
By taking stock of the EU experience and focusing on those provisions most relevant to innovation and competition, this paper aims to assess the CFPB’s proposal by investigating open banking’s challenging tradeoffs, identifying key features for its effective functioning, and providing policy suggestions for the forthcoming U.S. implementation.
The paper is structured as follows: Section II illustrates the economic rationale and challenges of regulatory-driven open-banking processes. Section III provides an overview of the EU and UK frameworks, while also analyzing recent proposals to facilitate open finance. Section IV analyzes the U.S. proposal, drawing attention to relevant differences from the EU context. Section V concludes.
Legislative initiatives to promote open banking belong to a more general wave of regulatory interventions intended to empower individuals with more control over data and to thereby unlock competition and innovation in both new and traditional markets.
The details vary from jurisdiction to jurisdiction and sector to sector, but data-sharing obligations generally include both data portability and interoperability. The former describes the ability to port from one platform to another any bulk data created through an individual’s use of a particular service. Data portability does not require systemic use of APIs, as it is accomplished via a one-time transfer at a specified point in time.[8] In contrast, open banking involves the creation of an in situ data right; i.e., rather than moving data among platforms, users are permitted to use their data within a given platform ecosystem and determine when and under what conditions third parties can access that in situ data.[9] Therefore, it represents a form of interoperability and, more specifically, belongs to the subcategory of data interoperability. Data interoperability refers to the ability to share and access data on a continuous and real-time basis, usually through APIs.[10]
Because market dynamics are shaped by consumer behavior, open-banking advocates assert that enhancing consumer engagement can play a crucial role in fostering effective competition. The fundamental policy objective of such data-sharing regulatory initiatives is to lower switching costs and avoid personal data lock-in by allowing consumers to switch smoothly or multi-home across platforms. In the case of open banking, this consumer empowerment is believed to strengthen their bargaining position with respect to banks. By gaining effective control of their own transaction data and allowing select TPPs to access such data, it is believed that consumers would be able to make informed choices among various banking and financial products and, with the help of data-driven tools, that they could receive personalized suggestions with the help of big-data analytics applied to their own economic behavior.
In summary, the goal of open banking is to increase competition, spur innovation, and make the market more contestable through data sharing. This is well-illustrated by the UK experience where, as we will see (infra Section III.C), the antitrust authority put forward data-sharing requirements as a regulatory remedy after a market investigation of the retail and business-banking sectors found weak competitive dynamics, including a high degree of market concentration and an extremely low switching rate.[11] UK authorities have even sought to measure the “loyalty penalty” that longstanding customers tend to pay for their inertia, estimating average annual gains they could realize from switching.[12]
Some open-banking proponents therefore seek to justify regulatory intervention on traditional market-failure grounds, noting that the banking sector in many countries suffers chronic deficiencies in its competitive dynamics. Without a legislative obligation to share date, banks may have valid reasons to decline access to or withhold sensitive information from TPPs, due to concerns about intellectual property, security, potential reputational risks, and liability issues.[13]
Nonetheless, it should also be noted that “open banking” does exist even where there is no regulatory mandate to share data. Indeed, even where banks are unwilling to collaborate with TPPs, third parties may gain access to customers’ accounts via screen scraping.[14] Screen scraping happens when consumers share their credentials with TPPs, who in turn impersonate the consumer, leaving them without control regarding what data is collected and how it is used and disclosed. The practice is known to increase the risks of inaccuracies, fraud, and data breaches. Indeed, the prevalence of screen-scraping practices may provide additional justification for open-banking regulations, as they represent a risky data-collection practice inconsistent with cyber-security best practices.
These concerns are further heightened by the fact that screen scraping allows TPPs access to all consumer data, rather than only those needed to provide payment and financial services. Therefore, open-banking proposals have also been advanced to guarantee consumer protection by providing a secure framework and ensuring a shift from screen scraping to developer interfaces (usually, credential-free APIs maintained by data providers or their service providers) as the most common means to access consumer data.[15] This would, it is argued, further enhance consumer trust in data sharing.
While there is consensus that developer interfaces should supplant screen scraping, significant disagreements have emerged around API standardization. Advocates particularly disagree about whether policymakers should mandate adoption of a common API standard or embrace a market-led approach that would leave banks free to develop their own interfaces or participate in privately led standardization initiatives.[16]
On the one hand, a common API standard could jeopardize dynamic competition among standards and undermine market incentives to innovate and develop high-quality interfaces. On the other hand, fragmented API standards could exacerbate the costs of interoperability, which in turn could translate into higher barriers for new entrants.[17] The unintended consequences that may arise from the absence of standardization are arguably worsened by conflicting interests among market participants—notably the lack of incentives for banks to grant access to TPPs.
Moreover, doubts have been expressed about how effective mandatory data sharing actually is in promoting competition. Growing concerns have emerged about financial-stability and monetary-policy risks generated by the entry of new players into the banking and financial-services industries.[18] Indeed, while open-banking regulations were intended primarily to create opportunities for fintech startups, whose services are otherwise constrained by lack of access to customer transaction data, the data-sharing obligations imposed on banks also tend to benefit unregulated financial-services players.
Notably, data-access rules have favored the entry of “Big Tech” firms, which initially entered the finance sector through payment services, but have swiftly diversified their offerings to include credit, insurance, and savings and investment products. While it remains unclear whether fintech startups will be able to compete effectively with legacy banks, rather than cooperate with them by providing complementary services,[19] Big Tech may represent a significant competitive threat to banks. The large tech platforms may be able to scale up quickly in financial markets by exploiting proprietary datasets derived from their non-financial operations (as well as analytical skills and advanced technologies) in order to provide consumers with personalized offers.[20] In this regard, from a competitive standpoint, there have also been questions about the asymmetric nature of data-sharing provisions that, in contrast with the goal of ensuring a level informational playing field, impose on banks a duty to grant access to TPPs without including a reciprocal obligation on the latter that would equally allow banks to enhance digital services.[21]
Further shortcomings and perils are associated with the role played by data aggregators (also known as API aggregators or API hubs). Emerging in response to the multiplicity of bank APIs available on the market, data aggregators act as intermediaries between banks and TPPs by integrating various APIs to offer a single implementation point for TPPs. From a technical perspective, data aggregators bring enhancements to the open-finance ecosystem. Indeed, providing a standardized API—irrespective of the specific APIs or services integrated—allows TPPs to seamlessly connect with various APIs without the need to handle the configuration and formatting intricacies of data and interfaces.
Data aggregators, however, also pose risks of market dominance.[22] Notably, due to their advantageous scale and extensive access to consumer financial data, the market might favor only a handful of major players. In other words, especially in a highly fragmented financial-services market, such as the United States, data aggregators may attract a critical mass of API-software developers that benefit from the same data-accumulation economics that may favor industry concentration and the entrenched dominant position of some Big Tech firms (i.e., strong economies of scale, scope, and network effects).[23] In addition, the API connection service delivered by aggregators can be viewed as a factor contributing to inefficiency, as it elongates transaction chains and introduces costs due to the fact that it is provided against compensation.
By and large, open banking’s rationale, aims, and tradeoffs suggest that one size does not fit all. Therefore, jurisdictions evaluating policy interventions to facilitate data sharing in banking and finance should adopt a tailored approach, taking stock of other countries’ experiences to carefully assess the benefits and drawbacks of market-led and regulatory-led regimes, respectively.
From a regulatory perspective, the EU led the way in open banking by introducing a sector-specific data-access right in 2015. The jurisdiction is now on the verge of further extending its legal framework to embrace open finance. While based on the same framework, the UK adopted a different technological model for standardizing data-sharing interactions between banks and TPPs, which has become noteworthy as one of the most advanced examples of mandated interoperability. Further, the EU’s ongoing review of its regulatory regime may offer some useful insights about both the successes and shortcomings of open banking, as well as how it compares to the UK regime.
The EU and UK therefore represent useful benchmarks for U.S. policymakers interested in incorporating the lessons learned from those experiences. Recent proposals in both the EU and UK to go beyond payment-account data in order to promote access to financial data could be equally relevant to the United States, as the CFPB’s rulemaking aims to facilitate a form of open finance.
The EU’s 2015 Directive on Payment Services (PSD2) introduced the access-to-account rule (XS2A rule), which requires account-servicing payment-service providers (ASPSPs) to share, upon user request, real-time data on customers’ accounts with TPPs—both payment-initiation service providers (PISPs) and account-information service providers (AISPs)[24]—as well as to execute payment orders.[25] PSD2 enables access without need for a contractual relationship between the ASPSPs and TPPs, and thus without compensation.
While open banking existed in the EU prior to PSD2, the directive’s aim was to provide a secure regulatory framework. Previously, TPPs operated in a largely unregulated environment and accessed customers’ accounts primarily by screen scraping.[26]
Under PSD2, data access is facilitated either through APIs, or by granting TPPs direct access to payment data using the interface that banks employ for customer interactions (customer-facing interface). In order to safeguard business continuity for TPPs, PSD2 requires ASPSPs that opt for a dedicated interface (PSD2 API) to also provide an alternative interface to TPPs (a fallback interface) in the event of malfunction or other issues with the dedicated interface. To facilitate the objective of promoting competition and innovation, PSD2 and its implementing regulatory technical standards (RTSs) chose not to impose a unique API standard; nearly 10 years later, there is still no single pan-European open-banking API standard.
A recent evaluation report concluded that PSD2 has been successful in reducing fraud via the introduction of strong customer authentication (SCA), which involves two authentication factors based on either knowledge (e.g., a password), possession (e.g., a card) or inherence (e.g., a fingerprint).[27] The report, however, also found that PSD2 was only somewhat effective in achieving a level playing field, and was a mixed success in the uptake of open banking in the EU.[28] Indeed, there have been recurrent issues as regards TPPs lacking effective and efficient access to data held by ASPSPs, with a particular imbalance between bank and nonbank service providers.[29]
Notably, the review found that neither ASPSPs nor TPPs are fully satisfied with the current situation.[30] The latter regularly complain about the performance of data-access interfaces, reporting that they experience difficulties in providing basic services due to inadequate and low-quality PSD2 APIs.[31] TPPs also note that, as API standards are set by the industry, this fragmentation leaves them in the disadvantageous position of bearing the costs of developing separate solutions to access different banks’ APIs.[32]
For their part, ASPSPs also express dissatisfaction, reporting significant implementation costs to develop APIs, as well as objections that PSD2 precludes them from charging TPPs for access to customer data.[33] In other words, banks perceive open banking purely as a regulatory burden, and argue that the free access does not offer incentives to create the best possible APIs.[34] Banks are similarly dissatisfied with the low use of their APIs, raising complaints that API aggregators pass on user data to unregulated third parties.[35]
Despite these findings on the imperfect functioning of open banking in the EU, the European Commission has chosen not to pursue radical changes.[36]
With regard to TPPs’ complaints, while acknowledging that a different solution might offer better access to data, the Commission’s proposed amendments to PSD2 do not include imposing a fully standardized EU data-access interface, on belief that the costs of introducing a new single API standard would outweigh the benefits.[37] Indeed, the Commission notes that, despite the existence of different API standards in the EU, the existing PSD2 API standards have substantially converged over time toward two primary solutions (i.e., the Berlin Group standard and the STET standard).[38] In addition, even if not envisaged by PSD2, the emergence of API aggregators that offer a paid alternative to a PSD2 API standard has lowered frictions arising from fragmented API standards.[39]
Nonetheless, starting from the premise that screen scraping should be out of bounds,[40] the proposal suggests streamlining the regime by removing the two interface requirements (i.e., a principal interface and a fallback interface) and imposing, as a general rule, mandatory use of APIs designed and dedicated for open-banking purposes to provide data access to TPPs.[41] Moreover, to ensure TPPs’ business continuity and ability to provide high-quality services to clients, the proposal would grant them the right to benefit from “data parity,” with the customer interface provided by ASPSPs to their users.[42]
In the same way, in response to banks’ requests to modify the PSD2 to allow for compensation to facilitate access to data, the proposed amendments would safeguard the current regime (i.e., TPPs benefiting from the PSD2 baseline services without contractual agreement or charging) but would allow contractual relationships to be established, accompanied by compensation for services that go beyond those required by the PSD2.[43] This would allow the development of “premium” APIs to provide transaction information from other types of accounts (e.g., savings accounts) and allow the schedule of recurring payments.[44]
Finally, to increase trust in open banking and empower consumers to be in full control of their data, the proposal would require ASPSPs to make a dashboard available for customers to monitor data access granted to open-banking service providers, and to easily withdraw or re-establish that access.[45]
Alongside proposals to revise PSD2, the European Commission has also delivered a legislative proposal on data access to financial information (FIDA), which would complement the XS2A rule with an obligation to provide access to financial data.[46]
The FIDA proposal builds on the same rationale as PSD2—i.e., promoting competition and innovation in a data-driven ecosystem by entrusting customers of financial institutions (i.e., both consumers and firms) with effective control over their financial data to benefit from financial products and services tailored to their needs.[47] The wording of the aims section of the proposal clearly resembles PSD2. According to the proposal, the lack of personalized financial products hinders the potential for innovation, as it restricts the ability to provide a broader range of choices and financial services to consumers who could otherwise gain advantages from data-driven tools that help them make informed decisions, easily compare offerings, and switch to more favorable products aligning with their preferences based on their data.[48] A particular emphasis is placed on small players, as they are assumed to suffer most from existing barriers to business-data sharing.[49]
In addition, the FIDA proposal adopts the same approach as PSD2 (confirmed by its proposed revision) toward the lack of reciprocity in data-access obligations. As mentioned above, this approach has garnered criticism for being at-odds with the proclaimed goal of leveling the informational playing field. Against the risk of favoring Big Tech firms over financial incumbents and new fintech entrants, the Commission notes that the Digital Markets Act (DMA)[50] would ensure reciprocity in data access between financial-sector firms and large technology companies.[51] Indeed, under the DMA, gatekeeper platforms are required to ensure real-time access to data provided or generated on the platform by business users and consumers in the context of core platform services.
But to safeguard financial stability, market integrity, and consumer protection, the proposal lays down eligibility rules on access to customer data, establishing that the latter can be accessed only by regulated financial institutions or firms authorized as financial-information service providers (FISPs).[52] The provision applies the principle of “same activity, same risks, same rules,” according to which all financial-market participants that carry out the same activity and generate the same risks ought to be subject to the same standards for consumer protection and operational resilience.[53]
In a nutshell, the FIDA initiative is intended to extend the open-banking framework to open finance, and it proceeds from the same customer-centric approach, building on the lessons learned in the PSD2 review.[54] Therefore, while the FIDA proposal includes the same amendments related to data-access permission dashboards for customers,[55] it differs significantly from the proposed revision of PSD2 with regard to envisaged solutions against the risk of a low-quality and fragmented API landscape.
Notably, the FIDA proposal explicitly acknowledges that making data available via high-quality APIs is essential to facilitate seamless and effective access to data. Seeking to safeguard incentives for data holders to invest toward this aim, the proposal declares that is appropriate to allow them to request reasonable compensation from data users.[56] Such a solution would be in line with the principle recently introduced in the Data Act of a contractual data-sharing model.[57] Accordingly, under the FIDA proposal, a data holder may claim compensation only if the customer data is made available to a data user in accordance with the rules and modalities of a financial-data-sharing scheme.[58]
Moreover, as the consultation strongly indicated that the lack of standardization is a major obstacle to data sharing in finance,[59] the FIDA proposal imagines that market participants would be required to jointly develop common standards for customer data and interfaces as part of these financial-data-sharing schemes.[60] The option to empower European supervisory authorities to develop a single EU-wide standard for the entire financial sector was discarded because of its perceived drawbacks, complexity, and overall costs. More specifically, it was considered unlikely that a single standard would satisfy the diverse needs of data users in different segments of the financial-services industry, and that it would be challenging for public authorities to keep pace with technical developments by updating standards in a timely manner.[61]
The explanation proffered for this apparent discrepancy between open banking and open finance in the EU is simply one of path dependence. As open finance is an emerging market that would be regulated for the first time, it has no legacy compensation regime and no investments in APIs already made; therefore, it is believed there would be no risk of disruption.[62]
Building on the same framework as PSD2, the UK opted for a more extensive and invasive implementation of the XS2A rule. Indeed, while PSD2 is technology-agnostic, the UK promoted a standardized model of open banking. Notably, the UK Competition and Markets Authority (CMA) required the nation’s nine largest banks (CMA9) to agree on common and open API standards, data formats, and security protocols that would allow TPPs to connect to customers’ bank accounts according to a single set of specifications.[63] Further, a special-purpose entity, funded by the CMA9, was created to oversee the rollout of API standards and support parties in the use of such standards.
The CMA decided to promulgate this remedy after a review of the retail-banking sector found perceived structural and longstanding competitive weaknesses.[64] In particular, the UK antitrust authority investigated whether there were barriers constraining banks’ ability to enter or expand competition in personal current accounts (PCAs), whether weak customer response was a result of lack of engagement and/or barriers to searching and switching that dampened banks’ incentives to compete, and whether the level of concentration had an adverse effect on customers. The investigation revealed that the market was concentrated and, despite variations among banks in prices and quality, market shares remained stable over time. Indeed, the four largest UK banks accounted for more than 70% of consumers’ primary PCAs and had collectively lost less than 5% market share since 2005.[65] Further, the market study found that a substantial proportion of customers were paying above-average prices for below-average service quality, thus suggesting they would be better off switching products.[66]
Despite these premises, customer engagement was low. The survey reported that more than a third of respondents had been with their primary PCA provider for more than 20 years, over a half for more than 10 years, and only 8% of customers had switched PCAs to a different bank over the past three years.[67] Such results were even more significant when compared to switching rates in other sectors.[68]
Seven years since its introduction, the UK celebrates the success of its open-banking model, claiming significant take-up and accelerating growth. Today, more than 7 million consumers and businesses (of which 750,000 are small to medium-sized enterprises) use open-banking-enabled products and services.[69] The data show that customers show positive sentiment toward open banking, believing they are in better control of their personal finances. Most TPPs likewise find that the API-standardized implementation has been particularly effective.[70] For these reasons, the UK Government has announced the launch of open finance—i.e., its intention to extend its open-banking model beyond payment accounts to a broader range of financial services and products.[71]
The perceived success of the UK version of open banking was confirmed when an identical model was adopted in Australia, where the Australian Competition and Consumer Commission required the four major banks to share product-reference data with accredited data recipients and mandated the adoption of a single set of API standards for data sharing.[72] Australia’s open-banking requirements are part of an ambitious legislative initiative to introduce an economy-wide data-sharing framework, tested initially in banking and energy, and expected to eventually be extended to telecommunications, pensions, insurance, and other areas.
Once the jurisdiction that most clearly embraced a market-led approach to open banking and open finance, the United States appears on the verge of shifting toward the EU’s prescriptive and regulator-driven regime, with mandated sharing of financial data.
In 2021, the White House encouraged the CFPB to intervene in the banking market to “promote competition” consistent with the objectives stipulated in Section 1021 of the Dodd-Frank Act and, in particular, to consider commencing rulemaking under Section 1033 of the Dodd-Frank Act to facilitate the portability of consumer-financial-transaction data.[73] Section 1021 entrusts the CFPB with ensuring that all consumers have access to markets for consumer financial products and services, and that these be “fair, transparent, and competitive.” Section 1033 establishes that, subject to certain exceptions, any person that engages in offering or providing a consumer financial product or service shall make available to a consumer, upon request, information in its control concerning that product or service that the covered person obtained from said consumer. In addition, the CFPB shall prescribe standards applicable to covered persons to promote the development and use of standardized formats for information, including through the use of machine-readable files, to be made available to consumers under this section.
As a consequence of the White House’s 2021 executive order on competition, the CFPB in October 2023 proposed a Personal Financial Data Rights rule to activate the aforementioned provisions enacted by the U.S. Congress more than a decade ago.[74] Notably, in addition to ensuring that consumers can access covered data in electronic form from data providers, the proposed regulation would delineate the scope of data that TPPs can access on a consumer’s behalf, the terms on which data are made available, and the mechanics of data access.
First, the CFPB chose to prioritize certain types of consumer accounts. The scope of the rulemaking includes as covered entities those providing asset accounts subject to the Electronic Fund Transfer Act and Regulation E; credit cards subject to the Truth in Lending Act and Regulation Z; and related payment-facilitation products and services, and, as covered data, transaction information; account balances; information to initiate payment to or from a Regulation E account; terms and conditions; upcoming bill information; and basic account-verification information.[75]
The rulemaking also requires data providers to establish and maintain a developer interface for third parties to access consumer-authorized data under certain performance and security specifications.[76] In particular, the CFPB established that the performance of a developer interface cannot be commercially reasonable unless it has a response rate of at least 99.5 percent within 3.5 seconds. Despite the costs incurred to meet these requirements, the CFPB suggested forbidding data providers from imposing access caps and levying any direct fee for fulfilling a request.[77]
Further, the rulemaking seeks to promote standardization by supporting industry standards appropriately developed within a data-access framework (“qualified industry standard”).[78] Due to concerns about the pace of technological change,[79] rather than dictating technical standards, the CFPB suggested that indicia of compliance with certain provisions must include conformance to an applicable industry standard issued by a fair, open, and inclusive standard-setting body.[80]
The CFPB’s rulemaking builds on Section 1033 of the Dodd-Frank Act. As noted by some scholars, however, Section 1033 is “silent” on the core principles of open banking.[81] Indeed, the provision creating a data-access right for consumers does not expressly impose on financial institutions a duty to share such data with third parties. Therefore, in contrast with the EU PSD2, it is far from clear whether there is a legislative mandate authorizing the CFPB to promote open banking via interoperability obligations. Indeed, the lack of a clear regulatory mandate is arguably what has allowed a market-driven approach to open banking to emerge in the United States over the last 14 years.
More importantly to the present analysis, the U.S. context differs significantly from the EU, raising questions about the justification for regulatory intervention. These doubts involve both the spread of poor technological-data-access solutions and the respective markets’ structural competitive weaknesses. Regarding the former, the CFPB proposal places significant emphasis on screen scraping. CFPB Director Rohit Chopra has described the current regime as “broken,” with consumer access based on a set of unstable and inconsistent norms across market participants and with many companies accessing consumer data through activities like screen scraping.[82] The proposal thus seeks to move the market away from these risky data-collection practices.[83]
But while acknowledging that screen scraping has allowed open banking to grow quickly in the United States,[84] the CFPB also reports that a large and growing number of consumers currently access their financial data through consumer-authorized third parties, and that the share of access attempts made through screen scraping has declined by a third since 2019.[85] According to the CFPB, the recent growth in traffic through credential-free APIs reflects the technology’s adoption by some of the largest data providers, covering tens of millions of covered accounts.[86] The bureau estimates that API use has grown substantially over the last five years, as the annual number of consumer-authorized access attempts approximately doubled from 2019 to 2022.[87] The U.S. market therefore already appears to be moving away from screen scraping and toward the use of APIs.
Moreover, the U.S. banking and financial-services sector is characterized by a large degree of fragmentation. As noted in the literature, such extreme fragmentation is “stark” when compared with the EU and other jurisdictions that have adopted open banking and open finance.[88] In response, U.S. financial institutions have undertaken initiatives to promote API standards, which already include private standard-setting bodies such as the Financial Data Exchange (FDX). The result has been a commingling of financial institutions, data aggregators, fintechs, payment networks, and consumer groups with the objective of “unifying the financial services ecosystem around a common, interoperable and royalty-free technical standard for user-permissioned financial data sharing.”[89]
But such efforts for industry-supported API standards have been controversial.[90] Indeed, an additional peculiar feature of the U.S. financial-services industry is the emergence of a relatively concentrated data-aggregation market, where a handful of players serve the entire sector.[91]
In summary, while the two primary rationales for regulator-driven open banking in other jurisdictions are chronic deficiencies in market contestability and the widespread use of screen scraping, neither of these features are present in the U.S. scenario. Since regulatory intervention is context-dependent and entails complex tradeoffs and sensitive choices (see supra Section II), the absence of these justifications raises doubts about the potential added value of the CFPB’s initiative—specifically, whether any benefits to innovation, competition, and consumer choice will outweigh regulatory costs.
While the marked differences between the U.S. and EU landscapes raise questions about the rationale for a U.S. shift toward regulator-led open banking, a glance at the EU’s recent review of its open-banking regime underscores the degree to which the proposed CFPB framework may represent an unnecessary regulatory burden. In particular, there should be significant doubts about the competitive implications of the proposed rules, and particularly about the degree to which they would serve to ensure quality data-sharing and a level informational playing field.
Indeed, the CFPB’s primary justification for top-down intervention is to outlaw screen scraping, which is unanimously considered worrisome for data privacy, security, and accuracy.[92] The EU FIDA proposal highlights data accuracy as especially key for competition, noting that making data available via high-quality APIs is essential to facilitate effective access.[93] The CFPB proposal likewise assumes that the quality of data provided through open-banking APIs is greater than that collected through screen scraping.
But the recent review of the EU PSD2 noted TPPs’ dissatisfaction with the performance of data-access interfaces.[94] Notably, many TPPs complained that, despite the high costs of implementation, APIs are implemented differently and don’t always work.[95] At the same time, banks complain about the costs of PSD2 compliance, arguing that the mandated free access leaves them no incentive to offer the best possible APIs.[96] Given the significant implementation costs to develop high-quality APIs, the European Commission has supported a proposal to allow data holders to request reasonable compensation from data users.[97] More generally, the EU Data Act affirms that it is desirable to provide remuneration for data under fair, reasonable, and non-discriminatory (FRAND) terms in order to promote investment and safeguard appropriate incentives to develop high-quality interfaces.[98] Such compensation might include not only the costs incurred to make the data available, but also a margin to account for such factors as the volume, format, or nature of the data. By contrast, the CFPB proposal would impose performance specifications for the developer interface while forbidding any fee or charge in connection with establishing the required interface or receiving requests to make covered data available.[99]
Other CFPB provisions are inconsistent with open banking’s procompetitive goal of levelling the informational playing field. Notably, the CFPB replicates the asymmetric treatment imposed on financial institutions by the PSD2 (as well as by the current EU proposals), under which banks and other lenders have a duty to share account data, while no reciprocal obligation is imposed on data recipients. Restricting access and use of data may serve to hinder development of innovative products or services, and a bidirectional access-to-data-account rule in PSD2 could have been used to enhance digital-payment services. A system in which all eligible entities participate would be more dynamic and promote greater competition. Therefore, in principle, there is good reason to establish that accredited data recipients in a designated sector should also be obliged to provide equivalent data in an equivalent format, in response to a consumer request.[100] Further, an unbalanced data-sharing burden risks over-empowering new players (i.e., fintechs, Big Tech, and data aggregators) relative to legacy banks.
In a similar vein, the CFPB’s blanket prohibition on secondary data use could yield further anticompetitive shortcomings by imposing limits on data flows—namely on the use of covered data for targeted advertising and cross-marketing, even when those data are de-identified.[101] Indeed, such restrictions are at odds with core open-banking principles. As open banking is consumer-centric and aims to promote consumer empowerment to spur innovation and competition, it should abandon purely paternalistic approaches focused only on consumers’ vulnerabilities. Instead, open-banking principles inherently endorse a proactive strategy based on consumers’ ability to manage their data and choose which parties should use it to offer new products and services.[102] An outright ban on targeted advertising and cross-marketing instead reduces consumer choices and their opportunities to discover new products and services. By further hindering the level informational playing field, such a prohibition would favor incumbents over newcomers and challengers.
Finally, following the EU, the CFPB would adopt an open-banking regime with mandatory data sharing, but without regulator-supplied technical standards. Similar to EU policymakers—and in contrast with UK and Australian regulators—the CFPB argues that detailed technical standards are too complex and unsuited to the pace of technological change, even though they would be particularly well-suited to the excessively fragmented U.S. market.[103] In supporting the development of common standards through standard-setting organizations, the CFPB’s proposal is similar to the European FIDA proposal, although the latter mandates participation by financial institutions, data holders, and data users in data-sharing schemes. Indeed, under the FIDA proposal, data that falls within the scope of the sharing obligation would only be available to members of a financial-data-sharing scheme.
The concerns about whether such an invasive intervention will be “future proof” are compelling, especially given the size of the U.S. financial market. But a UK-style remedy would at least be effective against the only potential risk of market dominance—that of a small handful of data aggregators emerging as a response to the peculiar fragmentation of the U.S. market. In this regard, there should be doubts about whether it will be effective to entrust standard-setting bodies to develop “qualified” standards within the CFPB’s framework.[104] In particular, it is unclear what value would be added relative to the way that market-led open banking is currently delivered in the United States, as it already includes industry standard-setting initiatives (e.g., FDX). Subjecting standard-setting organizations to CFPB vetting regarding their fairness, openness, and inclusiveness does not seem like a game changer. On the contrary, it appears to be just another unnecessary regulatory burden, apparently unfit to address the purported risks of standards controlled by dominant incumbents or intermediaries, thus “enabl[ing] rent-extraction and cost increases for smaller participants.”[105]
Following the EU and the UK, about 80 countries have recently engaged in government-led open-banking initiatives.[106] The United States is on the brink of joining the club. But even without a regulatory framework to mandate data sharing, open banking is already flourishing in the U.S. market. Therefore, it’s important to understand why the country that has been at the forefront of market-driven open banking would shift to a compulsory regime, as well as what model inspired this change.
The EU’s regulator-driven open-banking regime relies on the twofold rationale of promoting fintech competition and safeguarding consumers from screen-scraping practices. But the EU’s background differs significantly from the U.S. scenario. Rather than being highly concentrated, the U.S. market seems paradoxically to suffer from the opposite problem—namely, excessive fragmentation. As a result, the competitive issue that has emerged in the United States is one of market concentration at the intermediary level (i.e., data aggregators), rather than upstream (i.e., banks). Moreover, as the CFPB acknowledges, the U.S. market has already been moving away from screen scraping, as testified by the exponential increase in the number of consumer-authorized access attempts in recent years.
The state of the U.S. open-banking ecosystem also flies in the fact of the traditional market-failure justification for regulatory intervention. In disregarding the peculiar features of the U.S. context, the CFPB’s proposal may miss badly in selecting effective technical solutions. Indeed, by replicating the EU approach, rather than the UK implementation, the CFPB discards the option of imposing single U.S.-wide standard because of its cost, complexity, and dynamic innovation shortcomings. While these concerns are well-founded, at the very least, an invasive technological solution would address the only potential competitive issue in the U.S. market, which is the role of data aggregators. Moreover, the CFPB ignores some useful insights from the recent review of the EU experience, which recommends allowing incentives to develop high-quality APIs by compensating banks for their efforts.
For all these reasons, there should be significant concerns about whether the CFPB’s initiative is needed and to extent to which such a top-down intervention would add value in the U.S. market.
Despite the ambiguous effects and challenging tradeoffs of open banking, it has been trendy of late and the government-led version has become widespread around the world. It is worth remembering, however, that regulatory models do not work in a vacuum. They are context-dependent and can be more or less effective depending on the particular features of the markets and countries involved. More importantly, regulation is not inherently preferable to market-led solutions. Regulation is just a pill for a disease—ideally, the cure for a market failure. If the latter is missing or is not properly detected, consumers effectively be asked to pay the price for an unneeded dress, however stylish it might be.
[1] Executive Order on Promoting Competition in the American Economy, White House (Jul. 9, 2021), https://www.whitehouse.gov/briefing-room/presidential-actions/2021/07/09/executive-order-on-promoting-competition-in-the-american-economy.
[2] Required Rulemaking on Personal Financial Data Rights, Docket No. 2023-CFPB-0052, U.S. Consumer Financial Protection Bureau (Oct. 19, 2023), https://www.consumerfinance.gov/rules-policy/notice-opportunities-comment/open-notices/required-rulemaking-on-personal-financial-data-rights.
[3] Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, 12 USC 53 (2010), §1033.
[4] See, e.g., Tania Babina, Saleem Bahaj, Greg Buchak, Filippo De Marco, Angus Foulis, Will Gornall, Francesco Mazzola, & Tong Yu, Customer Data Access and Fintech Entry: Early Evidence from Open Banking (NBER Working Paper 32089, Jan. 2024), http://www.nber.org/papers/w32089; Tobias Berg, Valentin Burg, Ana Gombovic, & Manju Puri, On the Rise of Fintechs: Credit Scoring Using Digital Footprints, 33 Rev. Financ. Stud. 2845 (Sep. 12, 2019); Thomas Philippon, On Fintech and Financial Inclusion (NBER Working Paper No. 26330, Sep. 2019), https://www.nber.org/papers/w26330.
[5] See, e.g., Access to Finance for Inclusive and Social Entrepreneurship. What Role Can Fintech and Financial Literacy Play? (OECD Local Economic and Employment Development (LEED) Papers, 2022), https://www.oecd-ilibrary.org/industry-and-services/policy-brief-on-access-to-finance-for-inclusive-and-social-entrepreneurship_77a15208-en; Isil Erel & Jack Liebersohn, Can Fintech Reduce Disparities in Access to Finance? Evidence from the Paycheck Protection Program, 146 J. Financ. Econ. 90 (Oct. 2022); Yoke Wang Tok & Dyna Heng, Fintech: Financial Inclusion or Exclusion? (IMF Working Paper No. 80, May 6, 2022), https://www.imf.org/en/Publications/WP/Issues/2022/05/06/Fintech-Financial-Inclusion-or-Exclusion-517619.
[6] See, e.g., Zhiguo He, Jing Huang, & Jidong Zhou, Open Banking: Credit Market Competition When Borrowers Own the Data, 147 J. Financ. Econ. 449 (Feb. 2023); Christine A. Parlour, Uday Rajan, & Haoxiang Zhu, When FinTech Competes for Payment Flows, 35 Rev. Financ. Stud. 4985 (Apr. 27, 2022).
[7] For an overview of the international landscape, see Babina et al., supra note 4; Shifting from Open Banking to Open Finance: Results from the 2022 OECD Survey on Data Sharing Frameworks (OECD Business and Finance Policy Papers, 2023), https://doi.org/10.1787/9f881c0c-en.
[8] Daniel Schnurr, Switching and Interoperability Between Data Processing Services in the Proposed Data Act, Centre on Regulation in Europe (Dec. 2022), 11, available at https://cerre.eu/wp-content/uploads/2022/12/Data_Act_Cloud_Switching.pdf.
[9] Bertin Martens, Geoffrey Parker, Georgios Petropoulos, & Marshall van Alstyne, Towards Efficient Information Sharing in Network Markets (Bruegel Working Paper No. 12, Nov. 10, 2021), https://www.bruegel.org/2021/11/towards-efficient-information-sharing-in-network-markets.
[10] On the various degrees of interoperability, see Jacques Cre?mer, Yves-Alexandre de Montjoye, & Heike Schweitzer, Competition Policy for the Digital Era, European Commission Directorate-General for Competition (2019), 58-59, https://op.europa.eu/en/publication-detail/-/publication/21dc175c-7b76-11e9-9f05-01aa75ed71a1/language-en.
[11] The Retail Banking Market Investigation Order 2017, UK Competition and Markets Authority (Feb. 2, 2017), https://www.gov.uk/government/publications/retail-banking-market-investigation-order-2017.
[12] See Oscar Borgogno & Giuseppe Colangelo, Consumer Inertia and Competition-Sensitive Data Governance: The Case of Open Banking, 9 EuCML 143 (2020).
[13] Impact Assessment Accompanying the Proposal for a Directive on Payment Service in the Internal Market, European Commission (Staff Working Document, 288 final, 2013), 137.
[14] Report on the Review of Directive 2015/2366/EU of the European Parliament and of the Council on Payment Services in the Internal Market, European Commission (COM(2023) 365 final), 4.
[15] See, e.g., Screen Scraping – Policy and Regulatory Implications, Australian Government – The Treasury (2023), https://treasury.gov.au/consultation/c2023-436961.
[16] For a literature review on the different modes of the standardization process, see Dize Dinçkol, Pinar Ozcan, & Markos Zachariadis, Regulatory Standards and Consequences for Industry Architecture: The Case of UK Open Banking, 52 Res. Policy 104760 (Jul. 2023).
[17] See, e.g., OECD, supra note 7, 32; Press Release, Final Report on the Sector Inquiry into Financial Technologies, Hellenic Competition Commission (Dec. 27, 2022), https://epant.gr/en/enimerosi/press-releases/item/2460-press-release-publication-of-the-final-report-of-the-fintech-sector-inquiry.html; Opinion on the Sector of New Technologies Applied to Payment Activities, French Competition Authority (Apr. 29, 2021), https://www.autoritedelaconcurrence.fr/en/opinion/sector-new-technologies-applied-payment-activities.
[18] See, e.g., Giulio Cornelli, Fiorella De Fiore, Leonardo Gambacorta, & Cristina Manea, Fintech vs Bank Credit: How Do They React to Monetary Policy?, 234 Econ. Lett. 111475 (Jan. 2024); Karen Croxson, Jon Frost, Leonardo Gambacorta, & Tommaso Valletti, Platform-Based Business Models and Financial Inclusion: Policy Trade-Offs and Approaches, 19 J. Compet. Law Econ. 75 (Mar. 2023); Claudio Borio, Stijn Claessens, & Nikola Tarashev, Entity-Based vs Activity-Based Regulation: A Framework and Applications to Traditional Financial Firms and Big Techs (FSI Occasional Paper No. 19, Aug. 3, 2022), https://www.bis.org/fsi/fsipapers19.htm; Johannes Ehrentraud, Jamie Lloyd Evans, Amelie Monteil, & Fernando Restoy, Big Tech Regulation: In Search of a New Framework (FSI Occasional Paper No. 20, Oct. 3, 2022), https://www.bis.org/fsi/fsipapers20.htm; Raihan Zamil & Aidan Lawson, Gatekeeping the Gatekeepers: When Big Techs and Fintechs Own Banks – Benefits, Risks and Policy Options (FSI Insights No. 39, Jan. 20, 2022), https://www.bis.org/fsi/publ/insights39.htm.
[19] See, e.g., Oskar Kowalewski & Pawel Pisany, The Rise of Fintech: A Cross-Country Perspective, 122 Technovation 102642 (Apr. 2023); Emma Li, Mike Qinghao Mao, Hong Feng Zhang, & Hao Zheng, Banks’ Investments in Fintech Ventures, 149 J. Bank. Financ. 106754 (Apr. 2023); Victor Murinde, Efthymios Rizopoulos, & Markos Zachariadis, The Impact of Fintech Revolution on the Future of Banking: Opportunities and Risks, 81 Int. Rev. Financ. Anal. 102103 (May 2022); Arnoud Boot, Peter Hoffmann, Luc Laeven, & Lev Ratnovski, Fintech: What’s Old, What’s New?, 53 J. Financ. Stab. 100836 (Apr. 2021); Luca Enriques & Wolf-Georg Ringe, Bank-Fintech Partnerships, Outsourcing Arrangements and the Case for a Mentorship Regime, 15 Cap. Mark. Law J. 374 (Jul. 31, 2020); Anjan V. Thakor, Fintech and Banking: What Do We Know?, 41 J. Financ. Intermed. 100833 (Jan. 2020); Aluma Zernik, The (Unfulfilled) Fintech Potential, 1 Notre Dame J. Emerging Tech 352 (Oct. 1, 2018); Rene? M. Stulz, FinTech, BigTech, and the Future of Banks, 31 J. Appl. Corp. Finance 86 (Sep. 2019); Xavier Vives, Digital Disruption in Banking, 11 Annu. Rev. Financ. Econ. 243 (Nov. 2019).
[20] For analysis of the debate on competitive opportunities and concerns coming from Big Tech’s entry into banking and financial markets, see Oscar Borgogno & Giuseppe Colangelo, The Data Sharing Paradox: BigTechs in Finance, 16 Eur. Compet. J. 492 (May 28, 2020).
[21] Miguel de la Mano & Jorge Padilla, Big Tech Banking, 14 J. Compet. Law Econ. 494, 503 (Dec. 4, 2018).
[22] Open Finance Policy Considerations (OECD Business and Finance Policy Papers, 2023), 30-31, https://doi.org/10.1787/19ef3608-en.
[23] See Dan Awrey & Joshua Macey, The Promise and Perils of Open Finance, 40 Yale J. on Reg. 1 (Feb. 28, 2022); Julian Alcazar & Fumiko Hayashi, Data Aggregators: The Connective Tissue for Open Banking, Fed. Res. Bank Kansas City (Aug. 24, 2022), https://www.kansascityfed.org/research/payments-system-research-briefings/data-aggregators-the-connective-tissue-for-open-banking.
[24] Account-information services and payment-initiation services are those that allow a payment-service provider access to a payment-service user’s data data where the provider neither holds the user’s account funds nor does it directly service his or her payment account. Account-information services allow for the aggregation in a single location of user data held by multiple account-servicing payment-service providers; payment-initiation services allow a payment to be initiated from a user’s account in a way that is convenient for both user and payee and without need for a payment instrument, such as a payment card.
[25] Directive 2015/2366 on Payment Services in the Internal Market, (2015) OJ L 337/35, Articles 64-68. For analysis of the XS2A rule, see Oscar Borgogno & Giuseppe Colangelo, Data, Innovation and Competition in Finance: The Case of the Access to Account Rule, 31 Eur. Bus. Law Rev. 573 (Apr. 15, 2019).
[26] European Commission, supra note 14, 4.
[27] Id., 3.
[28] Id.
[29] Id., 4.
[30] European Commission, supra note 13, 16.
[31] Id., 13-14.
[32] Id., 120.
[33] Id., 15.
[34] Id.
[35] Id.
[36] The legislative amendments to PSD2 are set out in two proposals that would separate the rules governing payment services’ conduct from rules on authorization and supervision of payment institutions. On the former, see, Proposal for a Regulation on Payment Services in the Internal Market and Amending Regulation (EU) No 1093/2010, European Commission, COM(2023) 367 final; on the latter, see, Proposal for a Directive on Payment Services and Electronic Money Services in the Internal Market Amending Directive 98/26/EC and Repealing Directives 2015/2366/EU and 2009/110/EC, European Commission, COM(2023) 366 final.
[37] European Commission, supra note 14, 4-5. See also European Commission, supra note 13, 42-43, stating that “[r]equiring a new standard would render the work done on all existing standards wasted. More fundamentally, imposing a single standard would mean abandoning the principle of technology neutrality and could risk being inflexible, not future-proof and hinder innovation, since new better standards for interfaces may arise in future.”
[38] European Commission, supra note 14, 4-5, reporting that the Berlin Group standard claims to account for 80% of the PSD2 APIs.
[39] Id.
[40] European Commission, Proposal for a Regulation on Payment Services, supra note 36, Recital 61.
[41] Id., Recital 57. Exemptions are allowed for cases of failure/unavailability of the dedicated interfaces and small ASPSPs for which a dedicated interface would be disproportionately burdensome (Recital 62).
[42] Id., Recital 59.
[43] Id., Recital 56.
[44] In a similar vein, see, Principles for Commercial Frameworks for Premium APIs, UK Joint Regulatory Oversight Committee (2023), available at https://www.fca.org.uk/publication/corporate/jroc-principles-commercial-frameworks-premium-apis.pdf.
[45] European Commission, Proposal for a Regulation on Payment Services, supra note 36, Recital 65.
[46] Proposal for a Regulation on a Framework for Financial Data Access and Amending Regulations (EU) No 1093/2010, (EU) No 1094/2010, (EU) No 1095/2010 and (EU) 2022/2554, European Commission, COM(2023) 360 final. In particular, the access provision would apply to the following selected categories of customer data: mortgage-credit agreements, loans, and accounts; savings, investments in financial instruments, insurance-based investment products, crypto-assets, real estate, and other related financial assets, as well as the economic benefits derived from such assets; pension rights in occupational-pension schemes; pension rights on the provision of pan-European personal-pension products; non-life insurance products; data which forms part of a firm’s creditworthiness assessment and that is collected as part of a loan-application process or a request for a credit rating.
[47] Id., Recital 2.
[48] Id., Recital 6.
[49] Id.
[50] Regulation (EU) 2022/1925 on Contestable and Fair Markets in the Digital Sector and Amending Directives (EU) 2019/1937 and (EU) 2020/1828 (Digital Markets Act), (2022) OJ L 265/1.
[51] Impact Assessment Report accompanying the Proposal for a Regulation on a Framework for Financial Data Access, European Commission, SWD(2023) 224 final, 113.
[52] European Commission, supra note 46, Recital 31.
[53] Report on Open Finance, Expert Group on European Financial Data Space (2022), 35, https://finance.ec.europa.eu/publications/report-open-finance_en.
[54] European Commission, supra note 46, Recital 49.
[55] Id., Recital 21.
[56] Id., Recitals 7 and 29. See also European Commission, supra note 51, 21; Expert Group on European Financial Data Space, supra note 53, 11.
[57] Regulation (EU) 2023/2854 on Harmonized Rules on Fair Access to and Use of Data and Amending Regulation (EU) 2017/2394 and Directive (EU) 2020/1828 (Data Act), (2023) OJ L1, Article 9.
[58] European Commission, supra note 46, Articles 5, 9-11.
[59] European Commission, supra note 56, 19.
[60] European Commission, supra note 46, Articles 9 and 10, Recital 25.
[61] European Commission, supra note 56, 55.
[62] European Commission, Proposal for a Regulation on Payment Services, supra note 36, Recital 55; European Commission, supra note 13, 47.
[63] UK Competition and Markets Authority, supra note 11. For further analysis, see Dinçkol, Ozcan, & Zachariadis, supra note 16; Borgogno & Colangelo, supra note 12.
[64] Retail Banking Market Investigation – Final Report, UK Competition and Markets Authority (2016), https://www.gov.uk/cma-cases/review-of-banking-for-small-and-medium-sized-businesses-smes-in-the-uk#final-report.
[65] Id., §46.
[66] Id., §54.
[67] Id., §65.
[68] Id., §66.
[69] Recommendations for the Next Phase of Open Banking in the UK, UK Joint Regulatory Oversight Committee (2023), available at https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/1150988/JROC_report_recommendations_and_actions_paper_April_2023.pdf; Joint Statement by HM Treasury, the CMA, the FCA and the PSR on the Future of Open Banking, UK Government (2022), https://www.gov.uk/government/publications/joint-statement-by-hm-treasury-the-cma-the-fca-and-the-psr-on-the-future-of-open-banking.
[70] European Commission, supra note 13, 195-196.
[71] UK Government, supra note 69. See also, Open Finance – Feedback Statement, Financial Conduct Authority (2021), available at https://www.fca.org.uk/publication/feedback/fs21-7.pdf.
[72] Competition and Consumer (Consumer Data Right) Rules 2020.
[73] White House, supra note 1.
[74] Consumer Financial Protection Bureau, supra note 2.
[75] Id., §§1033.111 and 1033.211.
[76] Id., §1033.311(c)(1).
[77] Id., §1033.301(c) and §1033.311(c)(2).
[78] Id., 21.
[79] Id., arguing that “[c]omprehensive and detailed technical standards mandated by Federal regulation could not address the full range of technical issues in the open banking system in a manner that keeps pace with changes in the market and technology. A rule with very granular coding and data requirements risks becoming obsolete almost immediately, which means the CFPB and regulated entities would experience constant regulatory amendment, or worse, the rule would lock in 2023 technology, and associated business practices, potentially for decades. In developing the proposal, the CFPB is mindful of these limitations and the risk that they may adversely impact the development and efficient evolution of technical standards over time.”
[80] Id., §§1033.131 and §1033.141.
[81] Awrey & Macey, supra note 23, 20. See also He, Huang, & Zhou, supra note 6, noting that open banking’s core principles do not stop at customer ownership of their own data.
[82] Rohit Chopra, Remarks at Money 20/20 (Oct. 25, 2022), https://www.consumerfinance.gov/about-us/newsroom/director-chopra-prepared-remarks-at-money-20-20.
[83] Press Release, CFPB Proposes Rule to Jumpstart Competition and Accelerate Shift to Open Banking, U.S. Consumer Financial Protection Bureau (Oct. 19, 2023), https://www.consumerfinance.gov/about-us/newsroom/cfpb-proposes-rule-to-jumpstart-competition-and-accelerate-shift-to-open-banking.
[84] Consumer Financial Protection Bureau, supra note 2, 7.
[85] Id., 185 and 213.
[86] Id., 187.
[87] Id., 185-186. Notably, the CFPB estimates that there were between 50 billion and 100 billion total consumer-authorized access attempts in 2022.
[88] See Awrey & Macey, supra note 23, 19 and 35-37, arguing that the U “is home to the world’s largest, most fragmented, and most diverse financial services industry.”
[89] About FDX – Our Mission, Financial Data Exchange, https://financialdataexchange.org/FDX/FDX/About/About-FDX.aspx?hkey=dffb9a93-fc7d-4f65-840c-f2cfbe7fe8a6 (last accessed Jun. 9, 2024).
[90] Consumer Financial Protection Bureau, supra note 2, 9.
[91] Awrey & Macey, supra note 23, 37. See also Consumer Financial Protection Bureau, supra note 2, 16.
[92] Consumer Financial Protection Bureau, supra note 2, 14-15.
[93] European Commission, supra note 46, Recital 7.
[94] European Commission, supra note 13, 14.
[95] Id., 191. See also, A Study on the Application and Impact of Directive (EU) 2015/2366 on Payment Services (PSD2), VVA & CEPS (2023), https://op.europa.eu/en/publication-detail/-/publication/f6f80336-a3aa-11ed-b508-01aa75ed71a1/language-en, estimating that TPPs spent €35 million on problems linked to accessing APIs and €140 million on maintaining legacy systems due to APIs not working properly.
[96] See VVA & CEPS, supra note 95, estimating €2.2 billion in total (one-off) costs for all ASPSPs for setting up of PSD2 APIs.
[97] European Commission, supra note 36, Recital 56; European Commission, supra note 56, Recital 29.
[98] Data Act, supra note 57, Recitals 46 and 47, and Article 9.
[99] Consumer Financial Protection Bureau, supra note 2, §1033.301(c).
[100] See, Review into Open Banking: Giving Customers Choice, Convenience and Confidence, Australian Government (2018), 44, https://treasury.gov.au/consultation/c2018-t247313, acknowledging that determining equivalent data for data recipients whose primary business is not financial services can be complex, and therefore recommending that, as part of the accreditation process for non-bank data recipients, the competition regulator should determine what constitutes equivalent data for the purposes of participating in open banking.
[101] Consumer Financial Protection Bureau, supra note 2, §1033.421(a)(2).
[102] Giuseppe Colangelo & Mariateresa Maggiolino, From Fragile to Smart Consumers: Shifting Paradigm for the Digital Era, 35 Comput. Law Secur. Rev. 173 (Apr. 2019).
[103] Consumer Financial Protection Bureau, supra note 2, 21. See also Rohit Chopra, Remarks at the Financial Data Exchange Global Summit, U.S. Consumer Financial Protection Bureau (Mar. 13, 2024), https://www.consumerfinance.gov/about-us/newsroom/prepared-remarks-of-cfpb-director-rohit-chopra-at-the-financial-data-exchange-global-summit, acknowledging that the EU approach led to fragmented or conflicting standards, which created complications for open-banking implementation and undermined interoperability, but simultaneously arguing that the opposite approach promoted in other jurisdictions to prescribe detailed technical standards for data sharing would not work in the United States.
[104] Consumer Financial Protection Bureau, supra note 2, §1033.131 and 1033.141. But see also Chopra, supra note 103, announcing that, before finalizing the Personal Financial Data Rights rule, the CFPB would “codify” what attributes standard-setting organizations must demonstrate to be recognized under the rule.
[105] Consumer Financial Protection Bureau, supra note 2, 22.
[106] Babina et al., supra note 4; OECD, supra note 7.
ICLE Issue Brief Executive Summary Payment networks connect buyers with sellers. Success hinges on attracting sufficient participation on both sides of the market. Card issuers offer rewards, insurance, . . .
Payment networks connect buyers with sellers. Success hinges on attracting sufficient participation on both sides of the market. Card issuers offer rewards, insurance, fraud prevention, and other benefits that create incentives for use. Issuers can do so, in part, because they receive an “interchange” fee from acquiring banks, who in turn charge a fee to merchants (the “merchant discount rate” or MDR).
Price controls on these fees interfere with the delicate balance of the two-sided market ecosystem. Interchange-fee caps in various jurisdictions have led banks to increase other fees (such as monthly account fees and annual card fees), reduce card benefits, and adjust product offerings. As a result, consumers—especially those with lower incomes—face higher costs and reduced access to financial services. These costs generally exceed by a wide margin any consumer savings from reduced prices. Price controls on MDR, seen recently in India and Costa Rica, have also distorted the market by impeding competition and favoring larger players (big-box merchants and internet-platform-service providers, which are able to monetize in other ways), while harming smaller entities and traditional banks.
Instead of imposing price controls, governments should reduce regulatory barriers and provide core public goods, such as courts of law and identity registers, which enable competition, market-driven innovation, and financial inclusion.
Payment networks are integral to modern economies, facilitating the seamless exchange of goods and services across vast distances and among unfamiliar parties. This issue brief considers the effects of regulatory interventions on such networks, looking in particular at price controls on interchange fees and merchant discount rates (MDRs). While intended to reduce costs for merchants and consumers, the evidence shows these price controls impede competition and harm consumers.
For a payment network to be self-sustaining, there must be sufficient participation on both sides of the market—i.e., by both buyers and sellers. If too few sellers accept a particular form of payment, buyers will have little reason to adopt it. Likewise, if too few buyers hold a particular form of payment, sellers will have little reason to accept it. At the same time, payment networks must cover their costs of operation, including credit risk, monitoring costs, fraud risk, and investments in innovation. Payment networks typically address these two problems (optimizing participation and covering costs) simultaneously through various fees and incentives, thereby maximizing value to all participants.
Maximizing value often entails that one side of the market (usually, the merchants) subsidizes the other side (consumers) through an “interchange fee” received by the issuing bank from the acquiring bank. The interchange fee covers a much wider range of costs than the operational costs mentioned above. Specifically, it typically includes issuer costs associated with collection and default, as well as many of the additional benefits that cardholders typically receive, including various kinds of insurance and such rewards as cashback rewards and airline miles. The interchange fee, in turn, is typically covered by fees charged by the merchant’s acquiring bank (see Figure 1), known as the merchant discount rate (MDR) or merchant service charge (MSC).
Caps on interchange fees and/or MDR are price controls, which have the effect of reducing the incentive to supply the product subject to that control. Many countries have introduced price controls on interchange fees, and these have been much-studied. Section II presents a summary of the evidence of the effects of price controls on interchange fees.
By contrast, relatively few countries have imposed price controls on MDR and the effects of such price controls have rarely been scrutinized.[1] Section III thus offers an initial assessment of such effects. Finally, Section IV offers conclusions and policy recommendations.
This section considers the effects of price controls on interchange fees. While more than 30 jurisdictions have imposed such price controls, we focus on the jurisdictions for which we have the best evidence.[2] While each jurisdiction and each price control is unique, the effects appear to generalize readily. Therefore, the limited selection of jurisdictions here should be seen as typical examples.
This section begins with a brief description of the specific form price controls took in each jurisdiction. That is followed by a description of the response by (issuing) banks. Finally, the effects on consumers are evaluated.
Various jurisdictions have taken a variety of approaches to the imposition of price controls on interchange fees. The following are examples of some of the better-studied interventions.[3] These examples show what happens in the period immediately following the introduction of interchange-fee price controls. While some price controls have been repealed or changed, their effects are most transparent in the immediate aftermath of their implementation, and the inclusion of these examples thus remains instructive.
Spain imposed caps on interchange fees for both credit and debit cards through agreements with merchant associations and card schemes in two distinct phases: the first ran from 1999 to 2003, the second from 2006 to 2010.[4] During the first phase, caps were initially set at 3.5%, falling to 2.75% in July 2002. Caps were much lower during the second phase and were lower for large banks (over €500 million), whose credit-card interchange fees were capped at 0.66% in 2006, falling to 0.45% by 2010, than for small banks (under €100 million), whose credit-card interchange fees were capped at 1.4% in 2006, falling to 0.79% in 2010.
The Reserve Bank of Australia (RBA) introduced caps on interchange fees for credit cards in 2003 under a “cost-based framework,” which adjusted interchange fees based on processing costs. As a result, the RBA aimed in the first instance to reduce interchange fees by 40%, from an average of 0.95% in 2002 to 0.6% in 2003.[5]
Under a provision of the Dodd-Frank Wall Street Reform Act of 2010 known commonly as the “Durbin amendment,” the U.S. Federal Reserve imposed caps on debit-card interchange fees for large banks, as well as routing requirements for all debit-card issuers.[6] As a result, debit-card-interchange fees fell by about 50% for large banks almost immediately. Interchange fees on debit cards issued by smaller banks and credit unions initially fell by a smaller amount, and interchange fees on single-message (PIN) debit cards have now fallen to similar levels as PIN debit cards issued by larger banks.[7]
In 2015, the EU capped fees at 0.2% for debit cards and 0.3% for credit cards.[8] These are hard caps with few exceptions, and those rates rapidly became the norm for most transactions (with the exception of some domestic schemes that offer lower rates).[9]
Faced with potentially large losses of revenue, banks adopted numerous strategies to limit their losses, including, most notably:
Banks commonly increased other fees, including annual-card fees, account-maintenance fees, late fees, and interest on loans and credit cards. For example, in the United States, banks raised monthly account-maintenance fees and increased the minimum balance needed for a fee-free account.[10] In the EU, banks increased other fees and interest rates.[11]
Banks reduced the rewards and benefits associated with those cards that were subject to price controls. This included reducing or eliminating cashback rewards, points, and other incentives that were previously funded, in part, by interchange fees. For example, U.S. banks subject to the Durbin amendment generally eliminated debit-card rewards. In Australia, meanwhile, the average value of rewards fell by about 30%.[12]
Some banks shifted their focus to products not affected by the caps. In the United States, where the Durbin amendment applied only to debit cards, banks shifted their promotional efforts toward credit cards. In Australia, banks issued “companion” cards on three-party networks that were initially exempt. In some EU jurisdictions, banks have promoted business credit cards, which are exempt.[13]
Interchange-fee caps make the vast majority of consumers worse off, especially those with lower incomes. This outcome primarily arises from several interconnected factors:
As noted, in response to the reduction in interchange fees, banks have increased a range of fees, including higher account-maintenance charges (and higher minimum-balance requirements to qualify for free accounts); larger overdraft fees; increased interest rates on loans and credit cards; and higher annual fees on credit cards. These increased fees have disproportionately affected lower-income consumers, who may struggle more to maintain minimum-balance requirements or avoid overdrafts.[14]
The reductions in rewards and other benefits on cards subject to interchange-fee caps amount to a direct pecuniary loss for millions of consumers. Often, these losses far exceed the reduction in interchange fees that cause them. A case in point is insurance: credit-card-issuing banks are typically able to negotiate volume-based discounts on insurance, which means they pay less than would an individual seeking his or her own policy. But if there simply is not sufficient revenue to cover the continuation of such benefits, issuers are forced to withdraw it, as many issuers in the EU have done.
Larger account fees and increased minimum-balance requirements have resulted in an increase in unbanked and underbanked households in the United States, particularly among lower-income consumers.[15] As a result, more households have become reliant on check-cashing services, payday loans, and other high-cost financial services.
While larger merchants save on transaction fees, due to the lower interchange fees, these savings are not fully passed on to consumers in the form of lower prices. The degree of pass-through can vary greatly, depending on the competitive dynamics of various retail sectors. But in most cases, merchants have passed through the reduced costs associated with lower interchange fees at a lower rate than banks have passed through losses in fee revenue, in the form of higher-priced accounts, cards and services, and reductions in rewards. As such, consumers are, on net, worse off.[16]
While the intended goal of interchange-fee caps may be to reduce merchants’ costs and generate savings for consumers, in practice, consumers see few, if any, retail-price reductions, even as they experience significantly reduced benefits from their payment cards, as well as increased banking costs.
This section explores the effects of caps on merchant discount rates. As noted earlier, it is difficult to draw broad conclusions of the kind we were able to draw in Section II on the effects of interchange-fee caps. This is both because of the relative rarity of MDR caps, as well as the fact that they have—in the two cases examined here—coincided with other policy changes and broader economic and social phenomena that simultaneously have had significant effects on the payments system. The two case studies nonetheless offer salutary lessons about the problems inherent in imposing price controls on payment fees.
India’s MDR caps, which date back to 2012, were put in place as part of a series of interventions whose broad objective was to increase access to finance and shift transactions from paper to electronic money. These initiatives included (in order of implementation): a digital ID (launched in 2010); a domestic-card scheme and debit card (RuPay) with MDR caps (implemented in 2012); and a domestic faster-payments system (UPI, launched in 2016) with zero MDR for most transactions. This section focuses primarily on the implementation of UPI, its MDR caps, and the implications for consumers, merchants, and payment-service providers.
Until 2015, the two largest companies offering mobile phone-based payment services in India were Paytm and MobiKwik, which both relied on MDR to facilitate their expansion. MDR enabled these services to offer consumers cashback rewards and other incentives. MobiKwik signed up 1.5 million merchants and 55 million registered users by 2015,[17] while Paytm had 100 million registered accounts in 2015.[18]
Payment services are the core of Paytm’s business, contributing 58% of its revenue in Q3 2023 (although it fell slightly in Q1 2024).[19] These services arise from users making payments from mobile wallets stored on Paytm’s platform, using debit cards and credit cards. The company charges merchants an MDR that ranges from 0.4% to 2.99% of the transaction amount, depending on the payment type (for small-to-medium-size businesses).[20] MobiKwik, meanwhile, generates revenue from commissions and advertisements from its Zaak payment-gateway franchise subsidiary,[21] as well as loans—including short-term credit, buy-now-pay-later, and personal loans—and investment advice.[22] Of note, Zaak is also highly reliant on MDR as a source of revenue.[23]
In 2016, the National Payments Corporation of India (NPCI), a public-private partnership between the Reserve Bank of India (RBI) and the Indian Banks Association (IBA), launched the Unified Payment Interface (UPI), an open-source interoperable API that facilitates real-time transfers between individuals with accounts at participating banks that have integrated the API into their smartphone apps.[24] NPCI also built its own app, BHIM UPI, that is available directly and can also be white-labelled by banks and PSPs.[25]
By any measure, UPI has been enormously successful. In April 2024, more than 80% of all retail payments by volume and about 30% by value were made using UPI.[26]
PhonePe, which launched in 2016, and Google Pay, which launched in India in 2017, have from the outset operated exclusively on UPI. PhonePe launched as a wholly owned subsidiary of Flipkart, India’s largest online marketplace. This enabled it to leverage the marketplace’s then-100 million users, as well as subsequent growth of Flipkart’s user base.[27] Although PhonePe has now separated from Flipkart, it is still owned by Walmart, which bought Flipkart in 2018, and is thus able to leverage the retail giant’s merchant ecosystem.
Google, meanwhile, was able to leverage its brand recognition and to monetize Google Pay through a combination of advertising and its local online marketplace. It is noteworthy that, in a 2023 survey, Google was ranked the top brand in India, followed by Amazon and YouTube (which is owned by Google).[28]
PhonePe is now the largest payment network in India, with approximately 200 million active users; Paytm ranks second, with approximately 100 million active users;[29] Google Pay is third, with about 67 million active users;[30] and MobiKwik is fourth, with 35 million active monthly users in 2023.[31]
In April 2024, PhonePe and Google Pay together represented 87% of UPI transactions by volume and value (Table 1). Paytm was the third-largest payment app on UPI, representing 8% of transactions and 6% of value. The fourth-largest app was CRED, which is a members-only app aimed at individuals with higher credit scores.[32] Together, these top four apps represented 96.5% of transaction volume and 95.5% of transaction value. The remaining apps combined all had less than 5% market share between them, and none had more than 1% individually.[33]
SOURCE: NPCI
Since UPI transactions represented about 80% of India’s retail volume, this means that the combination of Google Pay and PhonePe represented more than 70% of all non-cash retail transactions in India by volume.
The reason such as high proportion of UPI payments come from the top four apps is that their operators have been able to monetize transactions and encourage adoption on both sides of the market without relying on MDR. NPCI prohibits MDR for most applications (exceptions are pre-paid debit and rechargeable mobile wallets, which since April 2023 have been permitted to charge up to 1.1% in MDR).[34]
These MDR caps on UPI have, however, made it less economically viable for payment-services providers (PSPs) to offer such incentives for consumers. Indeed, Paytm has recently switched from offering cashback rewards to consumers to offering cashback rewards to merchants—presumably because it realizes it has to compete with other payments ecosystems that run on UPI and therefore charge zero MDR.[35]
Like the interchange-fee caps explored in Section II, MDR caps change the economics of payment systems by reducing the ability of card issuers and payment-app operators to balance the two sides of the market through cross-subsidies. These effects became most visible after UPI went live in 2016 with zero MDR.
As noted, both PhonePe and Google Pay were able to leverage existing networks to attract both merchants and users (Flipkart, in the case of PhonePe, and Google’s search engine and other products, in the case of Google Pay). Having built a significant base of participants on both sides of the market, the companies have been able to monetize their payment systems through product advertising, upselling of related products, and in-app transactions, thereby reinforcing the network effects.
While MDR is prohibited on UPI, PhonePe usually charges a 2% transaction fee for its online-payment gateway service. Acting as a payment gateway carries little counterparty or credit risk, and is typically offered in other jurisdictions for a small flat fee. The 2% charged by PhonePe therefore effectively goes straight to the bottom line, or can be used to cross-subsidize participation, thereby further enhancing the PSPs’ market share. Indeed, in July 2023, PhonePe began offering its payment gateway for free to new customers (an own-side subsidy: existing users subsidize new users).[36]
Google Pay, meanwhile, has offered cashback incentives for use of the service on apps within its own (Android) ecosystem.[37] This encourages the use of Google Pay in much the same way that traditional rewards offer incentives to use other payment systems. The merchant beneficiaries are, however, limited to participants in its app system, for which Google charges a 30% transaction fee.
While Paytm’s share of UPI is low compared to PhonePe and Google Pay, it can monetize such transactions both by providing add-on financial services, such as insurance and investments, as well as through the MDR it charges on non-UPI transactions.[38] Paytm has also built a rewards program for merchants that encourages participation in its marketplace.[39]
Finally, CRED has partnered with a range of high-end brands to undertake targeted advertising, the revenue from which enables CRED to offer rewards to users of various kinds, including cashback rewards.[40]
While UPI has likely contributed to increased financial inclusion, the prohibition on MDR for most types of transactions has distorted the entire market toward merchants affiliated with the large mobile-payment ecosystems (PhonePe, Google, and Paytm) and a payment network targeted at higher-income customers (CRED). Meanwhile, this has come at a huge price for the majority of banks and other PSPs that facilitate payments on UPI. The Payments Council of India estimates that its members lose 55 billion rupees (US$660 million) annually as a result of the zero MDR on UPI and RuPay transactions.[41] This is effectively a transfer from those banks to the companies whose apps monetize UPI transactions.
India’s government partly offsets this loss through a subsidy to UPI participants of between 15 and 25 billion rupees.[42] But this amounts to a subsidy to PhonePe, Google, Paytm, and CRED, which is odd. Moreover, experience with other systems that impose restrictions on payment-transaction fees suggests that banks will seek to recover these losses via other fees.[43] To the extent that such additional fees fall on lower-income account holders, the effect on financial inclusion is likely to be negative.
India’s government has also announced that it intends to cap the share of UPI transactions for any one service provider to 30% by the end of 2024, with the goal of reducing the dominance of Google Pay and PhonePe.[44] It remains unclear how such caps will be implemented, but it is almost certain that whatever mechanism is adopted would cause other harmful effects. Indeed, there is something slightly absurd about introducing a cap on participation in order to address the perverse consequences of caps on MDR.
Given that the MDR caps are the cause of Google Pay and PhonePe’s combined dominance, a far better solution would be to lift those caps. Indeed, based on the evidence adduced here, removing the MDR caps would likely unleash competition and innovation. Instead of being dominated by a few giant players, UPI would become what its visionaries intended: an inclusive platform that facilitates participation by a wide range of players. The platform could then further expand access to payments, enhance smaller merchants’ ability to compete, and improve financial inclusion.
Costa Rica introduced price controls on payment cards in 2020. Legislative Decree No. 9831 authorized the Central Bank of Costa Rice (BCCR) to regulate fees charged by service providers on “the processing of transactions that use payment devices and the operation of the card system.”[45] The legislation’s stated objective was “to promote its efficiency and security, and guarantee the lowest possible cost for affiliates.” BCCR was tasked with issuing regulations that would ensure the rule is “in the public interest” and guarantee that fees charged to “affiliates” (i.e., merchants) are “the lowest possible … following international best practices.”
Starting Nov. 24, 2020, BCCR set maximum interchange fees for domestic cards at 2.00% and maximum MDR at 2.50%. Over a four-year period, BCCR has gradually ratcheted down both MDR and interchange-fee caps, as shown in Table 2.
An unusual feature of BCCR’s regulation is the simultaneous cap on both MDR and interchange fees, which has the effect of limiting revenue to both acquiring banks and issuing banks. This has likely reduced investments by issuers and acquirers and led to lower levels of system efficiency and speed, and possibly to increased fraud.
It is also worth noting that both interchange fees and MDR vary according to merchant type and location, in large part because the risk of fraud varies among different types of merchants. There is a danger, therefore, that imposing price controls on both MDR and interchange fees could make it unprofitable for acquirers to process payments for some riskier merchants. In other words, in its attempt to reduce merchant costs, BCCR may inadvertently (but predictably) prohibit some merchants from being able to accept payment cards. This is neither efficient, nor is it in the public interest.
Looking at the trajectory of the mean and median MDRs for various merchant categories in Costa Rica before price controls were imposed (as shown in Figures 1 and 2), MDRs were, on average, quite high (a mean of about 4%) but the medians were even higher (ranging from 4% to 10% for all categories except gas stations and passenger transportation). This significant difference between the mean and median MDRs suggests either that a large proportion of merchants represented a particularly high risk (e.g., from fraud and/or chargebacks) or that there was a lack of competition among acquiring banks (and perhaps even collusion)—or perhaps both.
SOURCE: Author’s calculations based on data from BCCR
If the previously high MDRs were a function of merchant-associated risk, capping MDRs would be expected to cause acquiring banks to drop some merchants. The data, however, show that the number of merchants increased from 2020 to 2022, which suggests that lack of competition among acquirers is a more likely explanation.[46]
To the extent that these high MDRs reflect a lack of competition among acquiring banks, the appropriate response would have been to seek to understand what was causing this lack of competition and then to remedy that directly. For example, if the lack of competition arose from regulations imposed by BCCR, it would be incumbent on BCCR to modify its regulations to reduce barriers to competition. Capping MDR does not address the underlying problem; indeed, it likely makes it worse, by inhibiting acquirers from being able to differentiate themselves on price or quality.
In competitive markets without price controls, prices evolve in ways that tend to maximize value for all participants. In payment networks, interchange fees play an important role, enabling issuers to develop appealing and competitive products with features that range from cashback rewards to travel insurance. This encourages customers to use the card or app in question, which, in turn, benefits merchants who see greater sales. The fees also facilitate associated innovations, such as AI-based fraud detection, contactless payments, and online token vaults.
When governments impose price controls on payment fees—whether in the form of caps on interchange fees or on MDR, or both—bank revenue from card transactions falls. Issuers (and acquirers, in the case of MDR caps) respond by increasing other fees, reducing card benefits, and reducing investments in improvements. The ecosystem becomes distorted, unbalanced, and fundamentally less competitive.
The beneficiaries of such interventions tend to be larger merchants and other participants in the system (including larger financial technology, or “fintech,” players). These players can leverage and reinforce their loyal customer base, and often charge fees for services (such as payment gateways) that are as high or higher than interchange fees, and even MDR.
India’s government recognizes the anticompetitive nature of its MDR caps, but appears to think that this is best-addressed by introducing new caps on participation. Costa Rica, meanwhile, appears to have suffered from a lack of competition among merchant acquirers, which drove up the cost of MDR—leading it to introduce caps on MDR.
But, in both cases, regulation is the problem, not the solution. In India’s case, various regulations—especially the caps on MDR for UPI transactions, as well as the government subsidies to UPI—have resulted in heavy concentration and impeded competition from fintech startups. Meanwhile, in Costa Rica, existing regulatory barriers likely impeded competition in the acquisition market, which enabled acquirers to charge excessive rates. This has prompted BCCR to impose MDR and interchange-fee caps that, in turn, have impeded competition in issuance.
The biggest losers from such interventions tend to be lower-income consumers, who end up paying higher bank fees and leaving—or not entering—the banking system. But there are many other losers, including the majority of consumers, and the many potential competitors that are excluded from participation because they are unable to monetize their investments via interchange and/or MDR fees.
Governments should not distort markets in these ways. Quite the opposite: they should be as neutral as possible. Rather than imposing price controls on payment systems, they might look to review and repeal existing government-created barriers to financial inclusion. These could include licensing requirements for banks that limit competition and enable acquirers to charge abnormal MDR rates.
In other words, rather than layer additional distorting regulations atop existing regulations, further harming the operation of complex private-market ecosystems, they should look for ways to reduce government-imposed barriers to competition. And, generally, they should limit themselves to the production of genuine public goods, such as courts and identity registers. Doing so will enable greater participation, competition, and innovation, which will drive financial inclusion.
[1] Other jurisdictions, such as Denmark and China, also have imposed restrictions on MDR/MSC, but this author was unable to adduce sufficient information about the nature and effects of these interventions to develop substantive analyses.
[2] We draw extensively on our earlier review: Julian Morris, Todd J. Zywicki, & Geoffrey A. Manne, The Effects of Price Controls on Payment-Card Interchange Fees: A Review and Update, (ICLE White Paper 2022-03-04 & George Mason L. & Econ. Research Paper No. 22-07, 2022), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4063914. See also Fumiko Hayashi & Jesse Leigh Maniff, Public Authority Involvement in Payment Card Markets: Various Countries, August 2020 Update, Fed. Res. Bank of Kan. City (August 2020), available at https://www.kansascityfed.org/documents/6660/PublicAuthorityInvolvementPaymentCardMarkets_VariousCountries_August2020Update.pdf.
[3] Morris et al., supra note 2.
[4] Juan Iranzo, Pascual Fernández, Gustavo Matías, & Manuel Delgado, The Effects of the Mandatory Decrease of Interchange Fees in Spain (Munich Personal RePEc Archive, MPRA Working Paper No. 43097, 2012), available at https://mpra.ub.unimuenchen.de/43097/1/MPRA_%20paper_43097.pdf.
[5] Press Release, Reform of Credit Card Schemes in Australia, Res. Bank of Austl. (Aug. 27, 2002), https://www.rba.gov.au/media-releases/2002/mr-02-15.html.
[6] H.R.4173 – Dodd-Frank Wall Street Reform and Consumer Protection Act, s.1075(a)(3); Debit Card Interchange Fees and Routing; Final Rule, 76 Fed. Reg. 43,393-43,475, (Jul. 20, 2011).
[7] Todd J. Zywicki, Geoffrey A. Manne, & Julian Morris, Unreasonable and Disproportionate: How the Durbin Amendment Harms Poorer Americans and Small Businesses, Int’l Cntr For L. & Econ. (Apr. 25, 2017), available at https://laweconcenter.org/wp-content/uploads/2017/08/icle-durbin_update_2017_final-1.pdf.
[8] Regulation (EU) 2015/751 of the European Parliament and of the Council of 29 April 2015 on Interchange Fees for Card-Based Payment Transactions, 2015, O.J. (L 123) 1, 10-11 (hereinafter “IFR”).
[9] Ferdinand Pavel et al., Study on the Application of the Interchange Fee Regulation: Final Report 89, European Commission Directorate-General for Competition (2020), https://op.europa.eu/s/zKl2.
[10] Mark D. Manuszak & Krzysztof Wozniak, The Impact of Price Controls in Two-Sided Markets: Evidence From US Debit Card Interchange Fee Regulation (Bd. of Governors of the Fed. Res. Sys. Fin. & Econ. Discussion Series, Working Paper No. 2017-074, 2017); Vladimir Mukharlyamov & Natasha Sarin, Price Regulation in Two-Sided Markets: Empirical Evidence From Debit Cards (SSRN Working Paper, 2019), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3328579.
[11] Interchange Fee Regulation (IFR) Impact Study Report, Edgar Dunn & Co. (Jan. 21, 2020), https://www.edgardunn.com/reports/interchange-fee-regulation-ifr-impact-assessment-study-report.
[12] Iris Chan, Sophia Chong, & Stephen Mitchell, The Personal Credit Card Market in Australia: Pricing Over the Past Decade, Res. Bank Of Austl. Bull. (2012), available at https://www.rba.gov.au/publications/bulletin/2012/mar/pdf/bu-0312-7.pdf.
[13] IFR, supra note 8, Art. 1(3)(a).
[14] Mukharlyamov & Sarin, supra note 10.
[16] Iranzo et al., supra note 4 at 34-37; Ian Lee, Geoffrey A. Manne, Julian Morris, & Todd J. Zywicki, Credit Where It’s Due: How Payment Cards Benefit Canadian Merchants and Consumers, and How Regulation Can Harm Them, Macdonald-Laurier Institute 1, 27 (2013); Morris, Zywicki, & Manne, supra note 7 at 23-29.
[17] Shabana Hussain, MobiKwik’s Journey and the Path Ahead, Forbes India (Apr. 6, 2015), http://forbesindia.com/article/work-in-progress/mobikwiks-journey-and-the-path-ahead/39905/1 .
[18] Paytm Reaches 100 Million Users, Business World (Aug. 11, 2015), https://businessworld.in/article/paytm-reaches-100-million-users–84698.
[19] Press Release, Paytm’s Earning’s Release for Quarter and Year Ending March 2024, Paytm (May 22, 2024), available at https://paytm.com/document/ir/financial-results/Paytm_Earnings-Release_INR_Q4_FY24.pdf.
[20] Paytm’s Pricing, Paytm, https://business.paytm.com/pricing (last visited Jun. 07, 2024).
[21] MobiKwik Consolidated Financial Statement, MobiKwik (2023), available at https://documents.mobikwik.com/files/investor-relations/statements/mobikwik/Consolidated-Financials-Sept2023.pdf; Report on the Audit of Special Purpose Interim Financial Statements, Tattvam & Co. (Dec. 31, 2023), available at https://documents.mobikwik.com/files/investor-relations/statements/zaakpay/zaakpay-financials-sept2023.pdf; Subsidiary Financials, MobiKwik, https://www.mobikwik.com/ir/subsidiary-financials (last visited Jun. 7, 2024); Status of Applications Received from Online Payment Aggregators (PAs) Under Payment and Settlement Systems Act, 2007, Res. Bank of India, https://www.rbi.org.in/Scripts/bs_viewcontent.aspx?Id=4236 (last updated Jun. 1, 2024).
[22] Id., Res. Bank of India.
[23] Pratik Bhakta, MobiKwik to Add Muscle to Its Payment Gateway Business, The Economic Times (May 13, 2017), https://economictimes.indiatimes.com/small-biz/startups/mobikwik-shifting-focus-to-payment-gateway-space/articleshow/58655807.cms?from=mdr.
[24] Unified Payments Interface (UPI), National Payments Corporation of India (2024), https://www.npci.org.in/what-we-do/upi/product-overview; UPI Live Members, National Payments Corporation of India (2024), https://www.npci.org.in/what-we-do/upi/live-members.
[25] BHIM, https://www.bhimupi.org.in (last visited Jun. 7, 2024); Pratik Bhakta, BHIM to Be the Right Platform for Small Banks to Enter Payment Space, The Economic Times (Feb. 3, 2017), https://economictimes.indiatimes.com/small-biz/security-tech/technology/bhim-to-be-the-right-platform-for-small-banks-to-enter-payment-space/articleshow/56945820.cms?from=mdr.
[26] Payment System Indicators, Res. Bank of India (Apr. 2024), https://www.rbi.org.in/Scripts/PSIUserView.aspx?Id=35.
[27] Alnoor Peermohamed, Flipkart Grows User Base to 100 million, Business Standard (Jun. 6, 2024), https://www.business-standard.com/article/companies/flipkart-grows-user-base-to-100-million-116092100216_1.html.
[28] Gaurav Laghate, Google, Amazon, YouTube Top India brands, Livemint (Jun. 27, 2023), https://www.livemint.com/companies/news/google-amazon-youtube-top-india-brands-11687887362055.html.
[29] Paytm Surpasses 100 Million Monthly Transacting Users for the First Time in Q3 FY24, Livemint (Jan. 22, 2024), https://www.livemint.com/companies/news/paytm-surpasses-100-million-monthly-transacting-users-for-the-first-time-in-q3-fy24-11705932856486.html.
[30] Michael G. William, How Many People Use Google Pay in 2023?, Watcher Guru (Sep. 14, 2023), https://watcher.guru/news/how-many-people-use-google-pay-in-2023#google_vignette.
[31] MobiKwik Continues Profitable Streak for Second Quarter in a Row, The Economic Times (Oct. 05, 2023), https://economictimes.indiatimes.com/tech/technology/mobikwik-continues-profitable-streak-for-second-quarter-in-a-row/articleshow/104183594.cms?from=mdr.
[32] CRED, https://cred.club/ipl (last visited Jun. 07, 2024).
[33] Eight other apps had between 0.25% and 0.75% of transaction volume and/or value: Amazon Pay, ICICI Bank Apps, Fampay, Kotak Mahindra Bank Apps, HDFC Bank Apps, WhatsApp, BHIM, and Yes Bank Apps.
[34] Upasana Taku, NPCI’s 1.1% Interchange Fee on UPI Payments Via Wallet – The Watershed Moment for Fintech in India, The Times of India (May 15, 2023), https://timesofindia.indiatimes.com/blogs/voices/npcis-1-1-interchange-fee-on-upi-payments-via-wallet-the-watershed-moment-for-fintech-in-india.
[35] Pratik Bhakta, Inside Paytm’s Cashback Offers for Retailers, The Economic Times (Jul. 7, 2023), https://economictimes.indiatimes.com/tech/startups/in-through-the-other-door-inside-paytms-cashback-offers-for-retailers/articleshow/101551675.cms?from=mdr.
[36] Mayur Shetty, PhonePe Cuts Fees for Payment Gateway Services, The Times of India (Jun. 14, 2023), https://timesofindia.indiatimes.com/business/india-business/phonepe-cuts-fees-for-payment-gateway-services/articleshow/100986915.cms.
[37] Manish Singh, Google’s New Plan to Push Google Pay in India: Cashback Incentives in Android Apps, TechCrunch (May 16, 2019), https://techcrunch.com/2019/05/16/google-pay-india-android-cashback.
[38] Paytm, supra note 20.
[39] An Overview of Merchant Discount Rate Charges, AMLegals (Mar. 15, 2024), https://amlegals.com/an-overview-of-merchant-discount-rate-charges.
[40] CRED Pay, https://cred.club/cred-pay/onboarding (last visited Jun. 7, 2024).
[41] Roll Back Zero Merchant Discount Rate on UPI, Rupay Debit Card Payments, Industry Body Payments Council of India Writes to Finance Ministry, The Indian Express (Jan. 23, 2022), https://indianexpress.com/article/business/banking-and-finance/merchant-discount-rate-rollback-on-upi-rupay-debit-cards-7737229.
[42] Pratik Bhakta, Fintechs Await Government Word on MDR Subsidy Allocation, The Economic Times (Feb. 22, 2024), https://economictimes.indiatimes.com/tech/technology/fintechs-await-government-support-for-promoting-digital-payments-for-current-fiscal/articleshow/107891943.cms?from=mdr.
[43] Morris et al., supra note 2.
[44] Ajinkya Kawale, NPCI to Review by End of Year Decision on 30% UPI Market Share Cap, Business Standard (Apr. 19, 2024), https://www.business-standard.com/markets/news/npci-to-review-30-market-share-cap-decision-by-year-end-124041901059_1.html.
[45] Author’s translations from the Spanish original are approximate.
[46] Fijación Ordinaria de Comisiones Máximas del Sistema de Tarjetas de Pago, Banco Centrale de Costa Rica (Oct. 2023), 12, available at https://www.bccr.fi.cr/en/payments-system/DocCards/Estudio_tecnico_2023_fijacion_ordinaria_comisiones_CP.pdf.
TOTM The U.S. Supreme Court delivered a major victory for free speech and struck a blow against government censorship-by-proxy yesterday in NRA v. Vullo: “Government officials cannot . . .
The U.S. Supreme Court delivered a major victory for free speech and struck a blow against government censorship-by-proxy yesterday in NRA v. Vullo: “Government officials cannot attempt to coerce private parties in order to punish or suppress views that the government disfavors.”
This is a major decision, and will have implications for free speech online, as the Court must soon consider similar facts in the social-media context in Murthy v. Missouri. But the case also illustrates the dangers that can attend government officials using even valid regulatory authority to strongarm private entities into doing things in ways they couldn’t do directly.
The Court’s unanimous opinion gets it right: “[A] government official cannot do indirectly what she is barred from doing directly… [she] cannot coerce a private party to punish or suppress disfavored speech on her behalf.”
